De Velin v. Commissioner

ESTELLE RUST DEVELIN, ARTHUR W. GANSCHOW AND CHARLES J. REYNICK, TRUSTEES OF THE MAXINE RUST TRUST, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

ESTELLE RUST (ESTELLE RUST DEVELIN), PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

ESTELLE RUST DEVELIN, ARTHUR W. GANSCHOW AND CHARLES J. REYNICK, EXECUTORS OF THE ESTATE OF EZRA RUST, DECEASED, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

De Velin v. Commissioner

Docket Nos. 15377, 15420, 17533.

United States Board of Tax Appeals

22 B.T.A. 1400 ; 1931 BTA LEXIS 1947 ;

April 30, 1931 , Promulgated

*1947 Royalties received by petitioners under provisions of a long-term lease of Minnesota ore lands are income to petitioners and not payments on account of the corpus of the estate, the character of the royalties not being altered by reason of having been obtained through bequest or inheritance.

W. E. Hayes, Esq., Charles D. Hayes, Esq., and John C. Hayes, Esq., for the petitioners.

Arthur H. Fast, Esq., for the respondent.

VAN FOSSAN

*1401 These proceedings, consolidated for hearing and decision, were brought to redetermine deficiencies in the income taxes of the estate of Ezra Rust for the years 1920, 1922, and 1923 in the amounts of $38,111.20, $6,269.87, and $7,559.05, respectively (Docket No. 17533); of Estelle Rust for the year 1923 in the amount of $10,809.62 (Docket No. 15420); and of Estelle Rust De Velin, Arthur W. Ganschow, and Charles J. Reynick, trustees of the Maxine Rust Trust, for the year 1923 in the amount of $6,024.27 (Docket No. 15377). James G. McPherson, one of the original executors and trustees, died and on motion Arthur W. Ganschow was substituted as such executor and trustee in Dockets Nos. 17533 and 15377.

The *1948 petitioners allege that the respondent erred in the following determinations:

(1) That payments made to the petitioners under the provisions of the last will and testament of Ezra Rust, deceased, were income instead of distributions of corpus. This issue is common to all three cases.

(2) That in Docket No. 17533 the computation of depletion allowance was improperly made under the applicable revenue acts and regulations promulgated thereunder.

FINDINGS OF FACT.

On October 2, 1899, Ezra Rust and George L. Burrows were the joint owners of certain lands in St. Louis County, Minnesota, subject to a one-third interest in the minerals therein owned by Gilbert B. Goff. On that day Rust, Burrows, and Goff entered into a lease agreement with the Lake Superior Consolidated Iron Mine, a corporation, leasing the said premises for a term of 50 years and 3 months from October 1, 1899, "for the sole purpose of exploring for, mining, taking out and shipping therefrom the merchantable iron ore (as well as other minerals hereinafter provided for) * * * found on, in or under the said lands." The lessee was given the right to construct all buildings, to make all excavations, roadways and other *1949 improvements and to use all timber, except pine, necessary to its mining operations. The lease named a royalty of 25 cents per ton for all iron ore mined and shipped on or after January 1, 1900, payments therefor to be made quarterly. The lessee agreed to mine and ship a specified minimum quantity of ore each year or upon failure so to do, to pay the lessors for such minimum quantity and apply the sum so paid on ore subsequently mined and shipped in excess of the minimum quantity. The lessors were given the right to terminate the lease on the failure of the lessee to comply with its terms, after a sixty-day default, and to reenter and repossess the leased land. The lessee had the right to terminate the lease on a *1402 thirty-day notice. The lessee agreed to pay all taxes and assessments against the land. The lessors had the right to inspect and check the weights of ore mined and the exploration and development of the work. Ezra Rust was to receive one-third of the royalty or 8 1/3 cents per ton.

The mining operations under the above described lease were carried on by the United Steel Corporation or one of its subsidiaries under its well established policy of conserving *1950 in and extracting all ore possible from the leased premises. The process of mining was what is known as open-pit operation and consisted of stripping the timber and soil from the iron deposits, extracting the ore by steam shovels and loading it on railroad cars placed on sidings extended into the mine. The cars were then hauled to docks, from which the ore was shipped to the lower lake ports. The mine under consideration was known as the Hull-Rust-Mahoning Operation. The property was one of the most valuable iron-ore deposits in Minnesota and was not excelled by any iron mine in the United States. The natural content of the ore ran from 51 1/2 to 56 per cent. The cost of operation under the Rust-Burrows-Goff lease was especially low, the overburden being remarkably light. The stripping had been completed by January 1, 1918. The mine excavation was approximately two miles long, one and one-fourth miles wide and about two hundred feet deep. The grades in the mine area were very light, so that twelve cars of ore could be hauled therefrom by one locomotive. After the ore is exhausted the surface of the land under lease will be practically valueless.

Ezra Rust died January 3, 1918. *1951 By his will, dated October 3, 1917, he devised and bequeathed to his wife, Estelle Rust, James G. McPherson and Charles J. Reynick, trustees, the Ezra Rust Mining Property under the provisions of the following fifth paragraph of his will:

I hereby give, devise and bequeath to my wife, Estelle Rust, James G. McPherson and Charles J. Reynick, all of the City of Saginaw, Michigan, as Trustees, and to their successors in said Trust, all my right, title and interest of every name, nature and description, in and to the Southeast Quarter * * * in the County of St. Louis, State of Minnesota, together with all my right, title and interest in and to one certain mining lease thereon, dated October 2, 1899, between George L. Burrows, Ezra Rust and Emma B. Rust, Gilbert B. Goff and Emily A. Goff, and Lake Superior Consolidated Iron Mines, a corporation organized under the laws of the State of New Jersey, and the right to collect, receive and recover all rents, royalties and income thereunder from said Lake Superior Iron Mines, its successors or assigns, together with all minerals, mining rights and mineral interest of every kind, name, nature and description, arising or growing out of or connected *1952 with said land above described, and the minerals therein, hereinafter for convenience called "EZRA RUST MINING PROPERTY," to be held in Trust, however, during the lives of my said wife, Estelle *1403 Rust, and my adopted daughter, Maxine Rust, and the lifetime of the survivor of them hereby giving and granting to said trustees and their successors in said trust, full power and authority to carry out the said trust for the following purposes, viz:

(1) To do all acts proper in the management and care of said trust property, * * *

(2) To pay to my said wife, Estelle Rust, for and during her lifetime, all the net rents, royalties and income from an undivided one-half of said Ezra Rust Mining Property, with all convenient dispatch, after the receipt of the same by them, and upon her death to pay, turn over and deliver to her heirs-at-law, or such legatees or devisees as she may in her last Will and Testament name, to receive the same during the lifetime of this trust, all the net rents, royalties and income from said undivided one-half of said Ezra Rust Mining Property, and upon the termination of said trust, turn over and deliver to the heirs-at-law of said Estelle Rust, or *1953 legatees or devisees designated in the last Will and Testament of said Estelle Rust, to receive the same, said undivided one-half interest in said Ezra Rust Mining Property.

(3) Said Trustees and their successors in said Trust shall, during the lifetime of this trust, turn over and pay all money, rents, royalties and income from an undivided one-half of the said Ezra Rust Mining Property above described, to the trustees of the Maxine Rust Trust created in paragraph Six of this Will and to their successors in that Trust. The said rents, royalties, moneys, and income from said Ezra Rust Mining Property so paid over to said Trustees of said Maxine Rust Trust, and to their successors in said trust, shall thereupon become and be a part of the said Maxine Rust Trust, and be governed by the terms of said Trust, and be disposed of to the persons and in the manner hereafter designated in the provisions for said Maxine Rust Trust.

Further provisions were made for the disposition of the property at the termination of the trust.

The sixth paragraph referred to above is as follows:

I hereby give, devise and bequeath to said Estelle Rust, James G. McPherson and Charles J. Reynick and *1954 their successors in this Trust, an undivided one-half of all the rest, residue and remainder of my personal estate, including all moneys, rents, royalties and income from said undivided one-half of said Ezra Rust Mining Property, as paid over to them, as provided for in the fifth paragraph of this Will, In Trust, however, for the following purposes, viz

(1) To collect from, receive and receipt for to the Trustees of said Ezra Rust Mining Property, and their successors in said Trust all the moneys, royalties, rents and income of every name, nature and description, arising, accruing or derived from the undivided one-half of the said Ezra Rust Mining Property hereinbefore described.

(2) To take possession of, hold, manage and care for all money and personal property covered by this Trust, with full power and authority to sell and exchange any or all stocks and bonds and other personal property covered by this Trust.

(3) To pay all taxes, insurance and expenses of every name, nature and description, of caring for and managing all of the property covered by this Trust, including compensation to said Trustees and their successors.

(4) To invest, re-invest and keep invested in *1955 income producing securities and property, all moneys, rents, royalties, proceeds, income and personal property *1404 coming into their hands from the property covered by this trust, and from the said Trustees of said Ezra Rust Mining Property.

(5) To pay out of the money and personal property coming into their hands under this Trust, to the legal Guardian of my said adopted daughter, Maxine Rust, until she shall attain her twenty-first year, all such sums of money as from time to time may be necessary to educate, support and maintain my said adopted daughter, Maxine Rust, liberally, according to her station in life, and shall pay: * * *.

Thereupon followed various provisions relating to the payment of portions of the principal to Maxine Rust at stated intervals and to the disposition of the property covered by the Maxine Rust Trust in the event of the death of the said Maxine Rust.

The same three above-mentioned individuals were named executors of the will. The will of Ezra Rust was duly probated and the said persons qualified as executors thereof. Ancillary administration was granted in Minnesota and the same persons appointed administrators.

The estimate of $69,165,662 *1956 tons made by the Minnesota Tax Commission as of January 3, 1918, was accepted by the Government as the known contend of the mine. The State of Minnesota placed a value of $47,121,160 on the property for State tax purposes. The respondent determined the value of the testator's interest of the Rust Mining Property to be $2,300,439.20 for estate-tax purposes. Under protest, the estate of Ezra Rust returned as income for 1920 royalties amounting to $292,687 from the Rust Mine, claiming deductions for depletion and for amounts paid to Estelle Rust and the Maxine Rust Trust. Similar returns for 1922 were made showing royalties of $157,451.85, with deductions claimed for $30,000 paid to each beneficiary. In 1923 royalties amounting to $302,238.50 were mentioned in the return, but were not included in the gross income. Estelle Rust received $50,000 in that year. The respondent allowed the depletion claimed in the several returns, but calculated it according to Hoskold's formula, using 6 per cent and 4 per cent as factors representing the risk rate and the capital redemption rate, respectively.

On January 17, 1930, the probate court for the County of Saginaw, Michigan, entered an *1957 order allowing the final accounts of the executors of the Ezra Rust estate and decreed that Estelle Rust and Maxine Rust each took a vested interest in the undivided one-half of the testators' estate, including the Ezra Rust Mining Property, "the corpus thereof to be paid to said Estelle Rust (and Maxine Rust) after deducting incidental costs of management." The court further decreed that the trustees of said estate were authorized and directed to state in their accounts as trustees, as a credit to the corpus, all the cash received from the realization of the Ezra Rust *1405 mining lease and to charge to the corpus of the estate all debts, costs of administration and all amounts paid to Estelle Rust and Maxine Rust as their distributive share of the cash received from the realization of the Ezra Rust mining lease. A similar provision was made relative to the accounts of the executors.

The value of the interest of Ezra Rust as the owner in fee and the lessor of the lands above described was $2,300,439.20 at the time of his death on January 3, 1918.

The petitioner acquiesced in the use of Hoskold's formula, but maintained that a risk rate of 4 1/2 per cent instead of 6 *1958 per cent should have been used as a factor in computing depletion.

OPINION.

VAN FOSSAN: The first question presented for our consideration is whether the payments made to the petitioners under the provisions of the will of Ezra Rust and according to the terms of the lease dated October 2, 1899, were distributions of the corpus of the estate of Ezra Rust or constituted income to the recipients.

It is to be borne in mind that the question before us arises under a Federal taxing statute. We are not here concerned with the general laws of property rights as such, nor are we called upon to delve into the niceties and tenuous distinctions that arise in such a study. We believe the law of this case to be well settled by the decisions of the Supreme Court of the United States. In , the Supreme Court held that mineral royalties received by the lessor corporation under the provisions of a mining lease strikingly similar to the one before us were income within the meaning of the taxing statute. The Court said:

* * * We think that the payments made by the lessees to the corporations now before the court were not *1959 in substance the proceeds of an outright sale of a mining property, but, in view of the terms of these instruments, were in fact rents or royalties to be paid upon entering into the premises and discovering, developing, and removing the mineral resources thereof, and as such must be held now, as then, to come fairly within the term "income" as intended to be reached and taxed under the terms of the Corporation Tax Act.

See also , where the Court had for consideration the status of the lessee under the income tax statute; ; . That an instrument such as the one here involved is a lease with rents and royalties and not a sale of any part of the land has long been the law of Minnesota. ; ; ; . The character of the rents or *1406 royalties so received is not altered by reason of having been obtained through bequest or inheritance. *1960 .

Petitioners contend that the decree of the probate court of Saginaw County, Michigan, entered January 17, 1930, is determinative of the nature and character of the amounts received by the executors and trustee of the Ezra Rust estate and that, accordingly, these amounts were part of the corpus of the estate and not taxable. While the judgments and decrees of courts of competent jurisdiction import absolute verity with respect to the ownership of property and in that respect are binding on Federal courts and on this Board (; ), it is to be noted that in this instance the property covered by the lease was located in Minnesota, while the probate court was a court of Michigan. However, the law with respect to the question at issue is so clearly settled that we do not feel it necessary to this opinion to enter upon a discussion of the subject matter of the probate decree or to attempt a decision as to the exact legal characteristics under the law of property of the estate held by petitioners. If the inference to be drawn from the *1961 decree of the Michigan probate court leads to a different conclusion from that announced herein, suffice it to say it is contrary to the decisions of the Supreme Court of the State of Minnesota and of the Supreme Court of the United States above cited.

The petitioners further assert that the beneficiaries also acquired the fee in the leased lands and that the fee, although subject to the lease, possessed a value over and above that comprehended in the rights of the lessor. The record discloses that the land itself will be practically worthless after the expiration of the lease and that the ore will be removed within the terms specified. Furthermore, no evidence was introduced to establish the value of the fee itself. Therefore, we can allot no portion of the royalties to a return of capital, but must include the entire amounts in income.

The second point in controversy is whether or not the respondent erred in using 6 per cent as a factor representing the risk rate when he computed, according to Hoskold's formula, the depletion allowable as a deduction for each of the years 1920, 1922, and 1923. The petitioners claimed that 4 1/2 per cent is the proper rate.

*1962 The character of the mining risk here involved was discussed by qualified experts called respectively by both sides. After careful consideration of all the evidence, we are not persuaded that petitioner has proved the rate of 6 per cent allowed by the Government to be unreasonable or inadequate. . *1407 The parties having agreed to the use of Hoskold's formula in making the computations, and having put in issue only the risk factor, we approve respondent's action in this respect.

Decision will be entered for the respondent.