Petition for Writ of Certiorari — Von Baumbach v. Sargent Land Co.

19

ently, meant to give its sanction to this correct

practice. The word ‘‘sustained’’ alone would

have covered an estimated depreciation, and the

intent of Congress in adding the word “ actually ”’

must have been to require some charging off of de-

preciation or some payment into a depreciation

fund. This is the construction given to the phrase

‘losses actually sustained’ in Baldwin’s Loco-

motive Works v. McCoach, 215 Fed. 967, 969; 221

Fed. 59, and the same meaning should be placed on

the phrase ‘‘a reasonable allowance for deprecia-

tion.”’

In addition, the act, when dealing with the re-

turn, provides that the corporation shall state

‘‘ separately any amounts allowed for depreciation

of property.’’ This ‘‘allowance ’’ must, of course,

be made by the company itself and not by the taxing

officials, and the language seems to point to some

actual things done by the corporation in regard to

‘¢ depreciation ’’ and not to a mere estimate.

(B) Depletion of capital can not be deducted as

“ depreciation.”

It may be admitted that under certain circum-

stances the term ‘“‘ depreciation ’’ might be given a

meaning broad enough to cover depletion of capital,

but it seems certain that this is not its ordinary

natural meaning. If a loaf of bread is eaten, no

person would say that it had ** depreciated.”’ If

a merchant has a stock of goods and he sells some

eee sic.

20

while others are damaged or affected by change of

fashion, he certainly would not call the processes

by the same name. In the case of a coal mine we

say that the machinery, shafts, etc., depreciate, but

we do not say that the coal depreciates by being sold. ,

The hardship of the case, if any, should not be met

by calling the process of sale something which it is

not, namely, ‘‘ depreciation.’’

The English decisions all seem to maintain, or, at

least, countenance the view that depletion of ecapi-

tal can not be deducted as depreciation. Lee v.

Neuchatel Asphalt Co. 41 Ch. Div. 1; Wilmer v.

McNamara & Co. Ltd. (1895), 2 Ch. 245; Coltness

Tron Co. v. Black, 6 App. Cas. 315; Alianza Co. v.

Bell (1904), 2 K. B. 666 (1905), 1 K. B. 184 (1906),

A. C. 18; Kauri Timber Co. Limited v. Commr. of

Taxes (1913), A. C. 771, 777. In the latter case the

Privy Council said:

With regard to the decided cases, the gen-

eral principle as to the impropriety of treat-

ing a quota of invested capital, or of the cor-

pus of the subject acquired, as a proper item

of debit from annual profits received, can no

longer be considered to be in doubt. [Italics

ours. ]

In Earl of Derby v. Aylmer (1915), 31 Times 1

Law Rep. 528, the question was whether, under the

language of the act of 1878, section 12, the Earl

of Derby was entitled to a deduction on account

of the diminished value of a stallion for breeding

oan

BERT AME CF RRR tle RAR RELI EME SAN BOE RPE I hi os

21

purposes owing to his increasing age. In holding

that he was not the court said:

That the diminished value was on the same

footing as the investment of money in a wan-

ing source of income.

It is true ‘ iat these cases go to some extent upon

the peculia” language of the acts involved, but they

appear aiso to be largely based upon the general

principle that a depletion of capital is not a proper

item of debit in an income account. The matter

was squarely ruled in the way we contend for under

the Civil War income-tax acts by the Commissioner

of Internal Revenue (Boutwell on the direct and

excise tax system of the United States, pp. 273,

274), and apparently this ruling was never ques-

tioned. In the case of Stratton’s Independence v.

Howhbert, 207 Fed. 419, 421, 422, Judge Pope said:

The ordinary definition of ‘‘ depreciation ”’

is the lessening of value. As applied to min-

ing properties the word carries with it, as in

the case of any other business, the idea of

deterioration in visible improvements, such

as mills and other surface structures and

perhaps the underground improvements so

far as they are put in by the hand of man,

and therefore, speaking popularly, when we

think of depreciation in mining properties,

we think of a lessening in value by time, or

perhaps by accident, of those physical ele-

ments which go to develop and to improve

the property. Now, does this meaning, com-

22

monly entertained and accepted and which is

common to every class of corporations, be-

come enlarged in case of mining companics

so as to make the extraction of ore likewise

an element of depreciation? The court’s

view is that it does not. This conclusion is in

part induced by the reasons which have been

above discussed in connection with the term

‘¢ net income ’’ and in part by the peculiar

nature of the mining business. This latter is

sui generis. It lives by dying. It is a busi-

ness that is intrinsically uncertain. The

segregation of part of a stock of goods is a

definite detraction from the whole. The ex-

eavation of a body of ore, however, may re-

veal other bodies and result in immeasurable

increment. The taking out of ore, while in a

sense depreciation from the body, very often

leads to the revealing of still larger bodies,

and thus results, not in a lessening of the

value of the claim, but in a great increase in

such value. Mining excavation, when prop-

erly conducted, is very often more a develop-

ment than a waste or a detraction. As ap-

plied to this class of corporation, having as

its purpose to exhaust—it may be a year

hence or a hundred years hence—the body of

ore for profit, the mere fact that ore may be

extracted does not in my judgment make the

value of such ore an element to be classed and

deducted as a depreciation of the property.

The court therefore holds, as to this second

provision of the statute, that the extraction

of ore does not constitute a credit in favor of

4

RTL RESTO RY ERY AIEEE LORY TEE INCA a

23

mining companies upon the account between

them and the Government when this excise

tax is to be assessed.

This same principle seems to be recognized by

the Supreme Court of Pennsylvania in Common-

wealth v. The Ocean Oil Co., 59 Pa. St. 61; Com-

monwealth v. Penn Gas Coal Co., 62 Pa. St. 241;

and by the Supreme Court of Wisconsin in a recent

decision under the income-tax act of that State.

Van Dyke v. City of Milwaukee, 159 Wis. 460. On

the other hand, no authority has been called to our

attention where depletion of capital has been

treated as ‘‘ depreciation,’’ except the decision of

the court below and the decision of Judge Lacombe

in the Nipissing Mines case, 202 Fed. 803.

CONCLUSION.

The judgment of the court below should be re-

versed and the cases ordered remanded to the dis-

trict court with directions to enter judgments for

the defendants.

Wiu1amM WALLACE, Jr.,

Assistant Attorney General.

NovEMBER, 1916.

O

7 ee *

% RE ODay ORNS map, “ = . -

Rees: SLEDGE NOES UMM RES SS ALORS Sears te,

Inthe Supreme Court of the Bnited States.

OcTroBER Term, 1915.

Nos.

FRED vON BauMBACH, COLLECTOR oF INTERNAL

Revenue, petitioner,

v.

SarGeENnT Lanp Company, A CORPORATION.

* §Frep von Bavumpacn, CoLLecTrorR oF INTERNAL

Revenue, petitioner,

v.

Surron LAnp CompANy, A CORPORATION.

FRED von BaumBAcH, COLLECTOR OF INTERNAL

Revenue, petitioner,

e v.

4 KEARSARGE LAND CoMPANY, A CORPORATION.

PETITION FOR WRITS OF CERTIORARI TO THE UNITED

STATES CIRCUIT COURT OF APPEALS FOR THE EIGHTH

CIRCUIT, AND BRIEF IN SUPPORT.

To the Supreme Court of the United States:

The Solicitor General, on behalf of the United

States, prays for writs of certiorari to review the

judgments of the Circuit Court of Appeals for the

Eighth Circuit in the above-entitled causes.

12229—15

2

QUESTION PRESENTED.

The question presented is whether corporations,

lessors in mining leases, are liable to pay a corpora-

tion tax on the royalties or rents received therefrom,

under the provisions of section 38 of the act of Con-

gress of August 5, 1909, 36 Stat. 11, 112.

THE FACTS.

At some early time the Pillsbury brothers became

the owners of large tracts of land in Minnesota

(R. 44). After removing the timber, they sold

undivided interests in the land, with a view of

developing its ore deposits, to Bennett and Long-

year (R. 45). Subsequently, and prior to 1902, the

undivided interests of the Pillsbury’s passed, on their

deaths, to their respective devisees, whose interests

were, in some cases, as small as 216ths, and some of

whom were minors (R. 45, 46). Under the laws of

Minnesota a minor can not make a lease for more than

25 years (R. 46). As ore leases are usually made for

a longer period, and as such small fractional inter-

ests embarrassed the efficient handling of the prop-

erty, it was determined to form corporations, and to

issue to the owners so much stock therein as would

exactly represent the undivided interest of each

(R. 47). Because the amount of land owned was

im excess of what the laws of Minnesota permitted

one corporation to own (R. 47), these three respond-

ent corporations were formed about February 20,

1906 (R.1, 13, 25). The original articles of each

provided (R. 8): ;

The general nature of its business shall be

the buying, owning, exploring and develop-

ing, leasing, improving, selling and dealing

in lands, tenements and hereditaments, and

the doing of all things necessary or incidental

to the things above specified.

This provision was amended December 29, 1909,

to read (R. 3):

‘‘The general purpose of the corporation is to

unite in one ownership the undivided frac-

tional interests of its various stockholders in

lands, tenements and hereditaments, and to

own such property, and, for the convenience

of its stockholders, to receive, and distribute

among them the proceeds of any disposition

of such property at such times, in such

amounts, and in such manner, as the board of

directors may determine.”

Article X (after stating that the title to the prop-

erty was in two classes (1) the heirs and devisees

of the Pillsburys, and (2) Bennett and Longyear),

recited (R. 10):

this corporation having been formed, by

mutual agreement of all said owners of both

classes, for the more convenient handling,

‘improvement, development and disposition

of said properties * * *.

Prior to the organization of these corporations cer-

tain so-called mining leases had been made by the

owners (R. 46), of which Plaintiffs Exhibit 15 is a

+

. sample (R. 97, 98). Probably all the leases had been

negotiated prior.to the organization of the corpora-

tions (R. 50, 51), but one of the most important

(Plaintiff's Ex. 16), was actually executed by the

Sargent Land Company on January 2, 1907 (R. 50).

These leases do not differ in any material respect

from the ordinary form of mining lease used generally

in this country. They “lease and demise” and “let

and demise” certain lands for the purpose of explor-

ing and taking out “the iron ore,” “the merchantable

iron ore” therein. One lease is for a term of 50

years, and the other is until all merchantable ore

grading 49 per cent and upwards has been mined and

shipped. In one lease the lessee agrees to pay “as

rent or royalty” 25 cents a ton. In the other the

lessee agrees to make graded payments of certain

amounts per ton “as royalty.”” Both leases provide

for minimum payments by the lessee in any event.

Since the lessee is bound by elaborate stipulations to

drill honestly for ore, to remove the ore in a proper

manner, and to keep accurate accounts so that the

royalty may be properly determined, the lessor re-

serves the right to enter on the land and drill for

itself, also to inspect the workings; and the lessee is

obligated to render daily and monthly statements as

to the ore mined and the ore shipped. The leases

contain the usual provisions as to the lessor’s right to

reenter and repossess on breach by the lessee of its

agreements; they provide that tenants’ fixtures shall

not be removed, and a lien is reserved on the ore till

it is sold.

0

The rights thus reserved to the lessor corporations

they constantly exercised during the taxing years in

question. They incorporated a company to inspect

the operations of the lessees, and such inspections

were regularly made (R. 55, 57-59). The controversy

between the Kearsarge Land Company and the Oliver

Mining Company, which appears on pages 77 to 80 of

the record, is a fair example of the close attention

and supervision given by these lessors to the opera-

tions of the lessees; and this was natural and nec-

essary since the amount of their royalty depended on

the extent to which, and the manner in which, the

lessees mined the ore. In addition, the corporations

did other things during the taxing years in question

which space does not permit a rehearsal of. Their

various activities are correctly set out by the district

judge in his opinion (R. 115, 116).

After the passage of the Corporation Tax Act the

corporations claimed that they were not liable thereto

because they were not doing business, and had no

income (R. 8). Being compelled to make a return,

they filed one showing depreciation in excess of their

gross income (R. 4,5). The Government nevertheless

assessed a tax upon them, the exact basis of which

does not clearly appear in the record (R. 5, 107, 108).

The record does show, however, that their claim for

depreciation was based entirely on the annual deple-

tion of capital from gradual waste of the ore supplies

(R. 109), and that no actual allowance or charge for

such so-called “depreciation’”’ was ever made by them

on their books of account (R. 49, 108).

18

bearing in mind the foregoing general principles,

the weight of the reasoning is in favor of the con-

struction we contend for. The strongest argument

lies in the connection in which the term ‘ depre-

eiation’’ is found. The deduction permitted is:

All losses actually sustained within the

year * * * including a reasonable allow-

ance for depreciation of property.

It seems clear, therefore, that ‘ depreciation,”’

as defined by the act, is within the class ‘‘ losses

actually sustained within the year ’’; and it seems

equally clear that a loss to be ‘‘ actually sustained ”’

must have caused some actual disservice or damage

to the person concerned. The mere depreciation

of stocks on the exchange, of goods from damage,

of a house from the weather, is not a loss “‘ actually

sustained ’’ until in some way a payment has been

made, or some analogous thing has been done which

constitutes what is termed a ‘ taking of the loss.’’

Any other view will open the door to fraudulent

or exaggerated estimates of losses by the taxpayer,

and this is especially true of ‘‘ depreciation.”? It

is almost impossible to adopt any rule for estimat-

ing ‘‘ depreciation ’’ which shall apply to all busi-

nesses, and there is never any difficulty in obtaining

the services of experts who will give as exaggerated

an estimate of ‘‘ depreciation’’ as the owner de-

sires. As a matter of fact, most prudent business

men do actually charge off annually a certain

amount for ‘‘ depreciation,’ and the act, appar-

7

122 Minn. 190. These decisions made a rule of prop-

erty in Minnesota as to mining leases, which the Cir-

cuit Court of Appeals, under the decisions of this

court, was bound to follow.

3. The decision of the Court of Appeals that the

plaintiffs had no income, or were entitled to cancel it

all by “depreciation,” is contrary to the decision of

this court in Stratton’s Independence, Limited, v.

Howbert, 231 U.S. 399.

4. The cases are of great public importance.

Many suits are pending, or are about to be brought,

to recover large amounts of taxes whose collection is

claimed to be illegal for the same reasons asserted

by the Circuit Court of Appeals in the present cases.

Moreover, the same point will constantly arise

under the Income Tax Act,'for if, as held by the

Circuit Court of Appeals, the corporations here had

no income within the meaning of the Corporation

Tax Act, equally individuals and corporations,

lessors in mining leases, would have no income

under the Income Tax Act, and the Gover ament

would be compelled to forego large amounts of taxes.

BRIEF IN SUPPORT OF THE PETITION.

:.

The respondents were ‘doing business’’ within the

meaning of the Corporation Tax Act.

This depends on whether the cases fall within

Mitchell v. Clark Iron Co., 220 U. 8. 107, 170, or

within United States v. Emery, Bird, Thayer Realty

Co., 237 U.S. 28.

RS iS

8

In Mitchell v. Clark Iron Co. the bill of complaint

alleged that the company was incorporated under

the laws of Minnesota (ch. 28, Laws 1876) and was

authorized to own and hold real estate; that it was

the owner of certain lands in Minnesota which it

had explored for iron;

That the defendant Clark Iron Company

some years ago made explorations for iron

ore upon the lands hereinbefore described, or

some portion thereof, and caused explora-

tions and developments to be made thereon,

resulting in the discovery of large bodies ot

iron ore in said premises, or some portion

thereof.

That for more than three years last past the

said lands upon which such deposits of iron

ore have been discovered, have been leased to

other parties or corporations for the purpose of

carrying on mining operations thereon and

taking out and removing iron ore, in consid-

eration of the payment to the said defendant

Clark Iron Company of rents or royalties

based upon the iron ore so mined and re-

moved, and that for more than three years last

past the said defendant Clark Iron Company

has not engaged in any business other than to

watch over and care for the said lands and

receive the rents and royalties accruing there-

from and distribute the same to its stockholders

by means of dividends, except such business

as has been necessary to transact in defending

its title to the said premises, in which the said

defendznt has incurred large expense, the

amount of which is unknown to this plaintiff,

REPRE

9

and that the only income the said defendant

company has had for more than three years

last past has been by way of rent and revenue

from the said lands, accruing by and thru

the leasing thereof for iron mining purposes

by way of rental paid by the lessees on a

royalty basis upon the iron ore mined and

removed from said lands. [Italics ours.]

The case was tried on demurrer, so that these were

the only facts before the court. This court, after

stating these facts as to the nature of the business

done by the company, said (220 U. S. 171):

We think it is clear that corporations

organized for the purpose of doing business,

and actually engaged in such activities as

leasing property, collecting rents, managing

office buildings, making investments of profits,

or leasing ore lands and collecting royalties,

managing wharves, dividing profits, and in

some cases investing the surplus, are engaged

in business within the meaning of this statute,

and in the capacity necessary to make such

organizations subject to the law. [Italics ours.]

In the Emery, Bird, Thayer Realty Company case

this court said (237 U. S. 32, 33):

* * * The question is rather what the

corporation is doing than what it could do,

228 U. S. 305, 306, but looking even to its

powers they are limited very nearly to the

necessary incidents of holding a specific tract

: of land. The possible sale of the whole would

be merely the winding up of the corporation.

That of a part would signify that the Dry

ee

10

Goods Company did not need it. The claim-

ants’ characteristic charter function and the

only one that it was carrying on was the bare

receipt and distribution to its stockholders of rent

from a specified parcel of land. Unless its bare

existence as an intermediary was doing business,

w 1s hard to imagine how it could be less engaged.

[Italics ours. ]

It is submitted that the cases at bar fall directly

within Mitchell v. Clark Iron Company. In that case,

as stated above, it was alleged that all the leases had

been made more than three years prior to the filing

of the complaint, February 10, 1910, so that since the

passage of the Corporation Tax Act the company had

done nothing but watch over its lands, and collect its

royalties. That case is decisive here.

In the Emery, Bird, Thayer Realty Company case,

while it is true that the corporation was carrying out

the functions for which it was incorporated, those

functions were purely passive. The corporation was

a mere conduit pipe. It was as though it had been

incorporated merely to collect the interest on invest-

ments, to receive income, so that it could be reached,

not by an excise, but only by an income, tax. In the

cases at bar, the companies were incorporated for the

very purpose of getting, in the operation and manage-

ment of mining leases, the advantage of a legal person

over minors and undivided interests. The corpora-

tions supplied the main capital—the land. The

lessees supplied the labor and, so to speak, the work-

ing capital. The product was divided between

them. This arrangement constituted a community

11

of interest between lessors and lessees, and required

the corporations to do what they did, namely, exer-

cise a constant supervision over the business to see

that they obtained their just royalties. This is

fully brought out in the opinion of the district judge

(R. 115-117), and it seems impossible to add any-

thing thereto.

II.

A mining lease is not a sale on installments, and the

royalties thereon are income.

(a) The Circuit Court of Appeals in deciding that a

mining lease was a sale relied entirely upon a remark

of Lord Blackburn in Coltness Iron Co. v. Black, 6

App. Cas., 315, 335, and on certain Pennsylvania

cases (219 Fed. 38, 39). But Lord Blackburn con-

cluded the remarks quoted, as follows:

But the argument that no income tax

should be imposed on what is, perhaps not

quite accurately, called rent reserved on a

mineral lease, because it is a payment by in-

stalments of the price of minerals forming part

of the land, any more than on the price paid

down in one sum for the out and out purchase

of the minerals forming part of the land, is,

I think, untenable.

As to the Pennsylvania cases, the Circuit Court of

Appeals faiied to notice Denniston v. Haddock, 200

Pa. St. 426, 428, where the court, after referring to the

cases relied on by the Circuit Court of Appeals, said

of mining leases:

Whether it would be better to call such an

instrument accurately what it certainly was at

12

common law, a lease without impeachment of

waste, or to endeavor to reconcile all the deci-

sions by calling it a conditional sale, is not

necessary at present to discuss. The point

to be noted is that the rules applicable to sales

are not to be applied indiscriminately to such

instruments but each is to be construed like

any other contract by its own terms.

Outside of the peculiar Pennsylvania cases, referred

to by the Circuit Court of Appeals, the authorities

are uniform that a mining lease is not a sale, and that

the rents or royalties thereon are income. United

States v. Gratiot, 14 Pet. 526, 538, 539; Hyatt v. Vin-

cennes Bank, 118 U.S. 408, 416; Raynolds v. Hanna,

55 Fed. 783, 800, 801; Tenn. Oil, Gas & Mineral Co.

v. Brown, 131 Fed. 696, 700; Daly v. Beckett, 24

Beav. 114; Lacey v. Newcomb, 95 Iowa, 287; Hen-

driz v. McBeth, 61 Ind. 478; Comley v. Ford, 65 W.

Va. 429; Eley’s Appeal, 103 Pa. St. 300; McClintock

v. Dana, 106 ib. 386; Shoemaker’s Appeal, ib. 392.

In Eley’s Appeal, supra, the court said (p. 306):

The word “income” means the gain which

accrues from property, labor or business. In

its ordinary and popular meaning, it is strictly

applicable to the periodical payments, in the

nature of rent, which are usually made under

coal and other mineral leases, and we have no

doubt it was used in that sense by the testator.

The case of United States v. Gratiot, supra, is not

cited by the Circuit Court of Appeals and is really

decisive of the question.

13

It is said (219 Fed. 42) of some of these decisions

that they arose under wills, and depended therefore

merely on the intent of the testator, but there were

in them no special indications of the testator’s inten-

tion, and he was merely presumed to have meant by

royalties in mining leases what everybody else meant

thereby.

(6) Prior to the time the rights of the United

States accrued the Supreme Court of Minnesota had

decided, in State v. Evans, 99 Minn. 220, that a min-

ing lease is not a sale but a lease, and that the royal-

ties on it are true rents or profits accruing from the

land, and this was affirmed in Boeing v. Owsley, 122

Minn. 190. That decision made a rule of property

in Minnesota, and the Circuit Court of Appeals was

bound to follow it.

Bucher v. Cheshire R. R. Co., 125 U. 8.

555, 583;

Clarke v. Clarke, 178 U. S. 186;

Abraham v. Casey, 179 U. 8. 210, 218;

East Cent. E. M. Co. v. Cent. Eureka Co.,

204 U.S. 266, 272;

Kuhn v. Fairmont Coal Co., 215 U. 8. 349,

360;

Foster v. Elk Ford Oil & Gas Co., 90 Fed.

178, 182;

York v. Washburn, 129 Fed. 564, 567;

Fretts v. Shriver, 181 Fed. 279.

It is contrary to all principle to have a mining lease

of land in Minnesota called a sale if the question arise

in the District Court for Minnesota, and a lease if it

arise in a State court.

14

(c) It follows that the royalties or rents received

by the respondent were income. The Circuit Court

of Appeals refers as authority to cases where single

sales of property have been held to be mere conver-

sion of capital, but the judges who delivered those

opinions were careful to state that the case of regular

sales for a business are different. The rentals

received on a lease of agricultural land or of a house

necessarily represent, to some extent, a depletion of

capital, and such leases may run so long that, unless

replacement of capital be made, the property is

worthless at the end of the term; but the rentals are

nevertheless income. On this aspect of the case

also Mitchell v. Clark Iron Company, supra, is decisive,

for the court must have held in that case that the

royalties on mining leases were income.

III.

The allowance as depreciation of all the receipts of

royalties in excess of expenses was erroneous.

This follows necessarily from Stratton’s Independ-

ence, Limited, v. Howbert, 281 U.S. 399, assuming that

the respondents were “doing business,’ and had

income. To say that they had income, but that, by

deducting as depreciation the very items which con-

stituted this income, they had none, is a reductio ad

absurdum. There is no evidence in the record that

the total amount of royalties received has any legiti-

mate bearing on the amount of depletion of capital,

figured either on a cost or on a value basis. The

15

opinion of the Circuit Court of Appeals went entirely

on the ground that a mining lease is a mere sale on

installments, and that everyone selling property on

installments is entitled to deduct, as depreciation, the

entire amount of the installment payments. The

statement of such a proposition is its best answer,

and, as to mining property at least, the case of

Stratton’s Independence, Limited, is decisive. What-

ever the respondents may be entitled to deduct as

depreciation, they are clearly not entitled, as matter

of law, to deduct the entire amount of their net

receipts. +

IV.

It is respectfully submitted that the writs should

issue as prayed.

Joun W. Davis,

Solicitor General.

-OcroBErR, 1915.

Suthe Supreme Court of the United States.

OcToBER TERM, 1915.

FRED von BaumBacu, CoLLector or IN-}

ternal Revenue, Petitioner,

: v.

Sarcent Lanp Company, A Corporation. |

>No. 707

FRED von Baumsacu, CoLLEcToR or In-)

ternal Revenue, Petitioner,

| v.

: Surron Lanp Company, A CoRPORATION. |

rNo. 708

ae Te

FRED von Baumsacn, CoLLEcTor or In-)

ternal Revenue, Petitioner,

v. No. 709

KerarsarGe Lanp Company, a Corpora-

tion. J

ON WRITS OF CERTIORARI TO THE UNITED STATES

CIRCUIT COURT OF APPEALS FOR THE EIGHTH

CIRCUIT.

Wg a gy oT an) ee

Fig eee, SE TaD oe ~

MOTION TO ADVANCE.

Comes now the Solicitor General, appearing on

behalf of the petitioner, and respectfully moves

the court to advance the above-entitled causes

36633—16

ia eae renee imran

6

The companies paid the tax assessed and brought

these actions to recover it. The district judge held

that the companies were “doing business” within

the meaning of the Corporation Tax Act. He held,

- however, that the rentals received were not income,

but were return of capital, and rendered judgment

for the full amount claimed by plaintiffs. The Cir-

cuit Court of Appeals affirmed the judgment (219

Fed. 31), holding (a) that the companies had no

income since the payments were merely capital pay-

ments; (b) that a mining lease is not a lease at all,

but a sale of the ore payable in installments, and

hence the rentals are not income; (c) that the com-

panies merely owned the right to the purchase price

of the ore, as in the case of a person owning promis-

sory notes payable in different years without interest

and that the annual payments could not be called

income; (d) that the companies were not “doing

business”’ within the meaning of the act.

REASONS FOR THE ALLOWANCE OF THE WRIT.

1. The decision of the Court of Appeals that the

plaintiffs were not “doing business” is contrary to

the decision of this court in Mitchell v. Clark Iron Co.,

220 U.S. 107, 170. .

2. The decision of the Court of Appeals that a

mining lease is a sale on installments is contrary to

the decision of the Supreme Court of Minnesota—

the State where the land lay, where the leases were

made and were to be performed—in State v. Evans,

99 Minn. 220 (Sept. 1906), and Boeing v. Owsley,

OCTOBER TERM, 1916.

Argument for Petitioner. 242 U.S.

The decision whether a corporation is carrying on business within the

meaning of the Corporation Tax Law must depend in each instance

upon the particular facts before the court; no particular amount of

business is required.

A corporation which has not reduced its activities to owning and hold-

ing property and the distribution of its avails, but maintains its

organization for continued efforts in pursuit of profit and for such

activities as are therein essential, is carrying on business within the

meaning of the act.

Respondent corporations, besides receiving and distributing among

their shareholders the royalties from a number of outstanding long

term ‘‘mining leases,’’ employed another company to inspect the

lessees’ operations and keep them to their contracts, made some

mining explorations at expense on other parts of their properties,

sold or leased other parcels and sold some timber, held, that they were

carrying on business within the meaning of the Corporation Tax

Law.

Quere: Whether this court, in determining whether royalties under

mining leases are income subject to the Corporation Tax Law, is

constrained to follow the decisions of the highest court of the State

in which the leased property is situate holding that such royalties

are rents and profits.

The ‘‘mining leases’”’ involved in these cases, were not equivalent to

sales of property; and the moneys paid by the lessees to the re-

spondents were not converted capital, but rents or royalties, and as

such were income, proper to be included in measuring their taxes

under the Corporation Tax Law. Stratton’s Independence v. How-

bert, 231 U.S. 399; Stanton v. Baltic Mining Co., 240 U.S. 103.

The depletion of a mine resulting from the removal of ore in the course

of its operation is not a “depreciation of property” for which a

deduction may be made under the Corporation Tax Law.

219 Fed. Rep. 31, reversed.

THE case is stated in the opinion.

Mr. Assistant Attorney General Wallace for petitioner:

The respondents were ‘‘doing business” within the

meaning of the Corporation Tax Act. The cases fall

within Mitchell v. Clark Iron Co., 220 U.S. 107, 170; not

within United States v. Emery, Bird, Thayer Realty Co.,

237 U. S. 28. In the cases at bar the companies were

VON BAUMBACH v. SARGENT LAND CO. 505

242 U.S. Argument for Petitioner.

incorporated for the very purpose of getting, in the

operation and management of mining leases, the ad-

vantage of a legal person over minors and undivided

interests. The corporations supplied the main capital—

the land. The lessees supplied the labor and, so to speak,

the working capital. The product was divided between

them. This arrangement constituted a community of

interest between lessors and lessees and required the

corporations to do what they did—namely, exercise a

constant supervision over the business to see that they

obtained their just royalties. This shows that the object

of a mining lease is to divide up the mining business, the

lessor furnishing most of the capital.

A mining lease is not a sale on installments, and the

royalties thereon are income. See the full remarks of

Lord Blackburn in Coltness Iron Co. v. Black, 6 App.

Cas. 315, 335. As for the Pennsylvania cases relied on by

the court below (219 Fed. Rep. 38, 39), see Denniston v.

Haddock, 200 Pa. St. 426, 428; they oppose all the other

authorities. Before the rights of the United States ac-

crued, the Supreme Court of Minnesota had decided, in

State v. Evans, 99 Minnesota, 220, that a mining lease is

not a sale but a lease, and that the royalties on it are true

rents or profits accruing from the land, and this was

affirmed in Boeing v. Owsley, 122 Minnesota, 190, and in

Minnesota v. Royal Mineral Association, 156 N. W. Rep.

128, notwithstanding the decision below. The decision in

State v. Evans made a rule of property in Minnesota, and

the Court of Appeals was bound to follow it.

The royalties or rentals, when received, constituted

gross income of the lessors. Mitchell v. Clark Iron Co.,

supra. Whether these ‘‘royalties” are called payments by

installment of a debt, or conversion of capital from one

form to another, they were, nevertheless, received by the

companies during the taxing years from the business done

by them with the advantages inherent in a corporate

506 OCTOBER TERM, 1916.

Argument for Petitioner. 242 U.S.

organization. They were the gross income of the com-

panies from such business, since gross income is nothing

but gross money receipts or revenue. They are therefore

within the very language of the act. Anderson v. Forty-

two Broadway Co., 239 U. 8S. 69. The distinction is plain

between a casual conversion of capital, Secretary of State v.

Scoble (1903), 1 K. B. 494 (1903) A. C. 299; Stevens v.

Hudson’s Bay Co., 101 Law Times Rep. 96; Gray v. Dar-

lington, 15 Wall. 63, 66, and a conversion occurring in the

regular course of business. Stratton’s Independence, Lid.,

v. Howbert, 231 U. 8. 399, 414, 415; Stanton v. Baltic

Mining Co., 240 U.S. 103, 114.

“Depreciation” cannot be ‘‘allowed” under the act

unless, and only to the extent that, actual deductions or

payments have been made on account of it. Just as

“‘income”’ must be an actual, not a hypothetical, receipt,

so “‘outgo” must be an actual, not a hypothetical, pay-

ment. It seems clear that ‘‘depreciation,” as defined by

the act, is within the class “losses actually sustained

within the year;” and it seems equally clear that a loss to

be ‘‘actually sustained”? must have caused some actual

disservice or damage to the person concerned. Baldwin

Locomotive Works v. McCoach, 215 Fed. Rep. 967, 969; 221

Fed. Rep. 59.

Depletion of capital cannot be deducted as “‘deprecia-

tion.” The latter term does not naturally include the

former. In the case of a mine the machinery, shafts, etc.,

depreciate, but we do not say that the deposit of mineral

depreciates by being sold. The English decisions all seem

to maintain, or, at least, countenance the view that deple-

tion of capital cannot be deducted as depreciation. Lee v.

Neuchatel Asphalt Co., 41 Ch. Div. 1; Wilmer v. Mc-

Namara & Co., Ltd. (1895), 2 Ch. 245; Coliness Iron Co. v.

Black, 6 App. Cas. 315; Alianza Co. v. Bell (1904), 2 K. B.

666 (1905), 1 K. B. 184 (1906), A. C. 18; Kauri Timber

Co., Ltd., v. Commr. of Taxes (1913), A. C. 771, 777. See

na eS

VON BAUMBACH v. SARGENT LAND CO. 507

242 U.S. Argument for Respondents.

Boutwell on the direct and excise tax system of the

United States, pp. 273, 274; Stratton’s I ndependence v.

Howbert, 207 Fed. Rep. 419, 421, 422; Commonwealth v.

Ocean Oil Co., 59 Pa. St. 61; Commonwealih v. Penn Gas

Coal Co., 62 Pa. St. 241; Van Dyke v. Milwaukee, 159

Wisconsin, 460. We know of no authority holding deple-

tion of capital equivalent to “depreciation” other than the

decision of the court below and that in the N ipissing Mines

Case, 202 Fed. Rep. 803.

Mr. John R. Van Derlip, with whom Mr. Burt F. Lum

and Mr. Kenneth Taylor were on the brief, for respondents.

The respondents were not corporations “organized for

profit.” The sole purpose of their organization was the

liquidation of the assets contributed, in undivided por-

tions, by the owners, with a view to the partition of the

whole and to enable them to realize the money equivalent

of their respective contributions, but with no view to

dealing, speculating, trading, or gain. The act means that

a corporation, to be subject to taxation, must be organized

to make profit from the carrying on or doing of business.

Lewellyn v. Pittsburgh, B. & L. E. Ry. Co., 222 Fed. Rep.

177, 183, 184; Smith v. Anderson, L. R., 15 Ch. Div. 247.

The words ‘organized for profit,” do not merely dis-

tinguish between charitable corporations and all others.

The suggestion that any corporation organized by private

persons for their own advantage or interest is organized for

profit is untenable. Such an interpretation is opposed to

the common acceptation of the words, and renders them

idle. For it is not sensibly conceivable that any persons

would organize a corporation, unless it would be of some

advantage to them. The tax is not a tax on incomes, nor

on corporations which merely receive incomes from prop-

erty. Zonne v. Minneapolis Syndicate, 220 U. S. 187;

McCoach v. Minehill &c. R. R. Co., 228 U.S. 295; Flint v.

Stone-Tracy Co., 220 U. 8. 149, 152. The receipt of inter-

508 ; OCTOBER TERM, 1916.

Argument for Respondents. 242 U.S.

est, rent, or other income is simply a concomitant of

property ownership. Pollock v. Farmers’ Loan & Trust

Co., 158 U. 8. 601, 625, 626. ‘‘ Profit” in this act signifies

the gain from a commercial or other active business, in-

volving “ordinary and necessary expenses”’ in the way of

rentals, salaries and other outgoes and obligations. Gray

v. Darlington, 15 Wall. 63; People v. Board of Supervisors,

4 Hill, 20. If the words “organized for profit” be ignored,

the act would apply to every corporation carrying on or

doing business, which, concededly, it does not.

Respondents were not ‘‘carrying on or doing business”

during the years for which the tax was assessed. There

was no substantial activity other than the receipt of

moneys payable to them under the outstanding mining

contracts and the distribution of such moneys to their

stockholders. It was only because the act was limited to

corporations doing business that its constitutionality was

sustained. Flint v. Sione-Tracy Co., supra.

In Mitchell v. Clark Iron Co., 220 U. S. 107, 170, the

question whether the Clark Iron Company was “doing

business” within the meaning of the statute was not an

issue.. This court assumed that the company was con-

-tinuing, after the passage and approval of the act, to

make leases from time to time, an activity, which, if it

existed, may be conceded to be doing business within the

statute.

The amendment of the articles of incorporation in

these cases conforms completely in its effect to the amend-

ment made by the Minneapolis Syndicate in the Zonne

Case, supra, and also in Abrast Realty Co. v. Maxwell, 206

Fed. Rep. 333; s. c., 218 Fed. Rep. 457.

In every case the question is determined not by the

power to act, but by the activities engaged in by the

corporation. Flint v. Stone-Tracy Co., 220 U. 8. 107, 145,

151; United States v. Emery, Bird, Thayer Realty Co., 237

U. S. 28, 32; Minehill &c. R. R. Co. v. McCoach, 192

VON BAUMBACH v. SARGENT LAND CO. _ 506

242 U.S. Argument for Respondents.

Fed. Rep. 670, 672; Public Service Ry. Co. v. Herold, 227

Fed. Rep. 500; State Line Co. v. Davis, 228 Fed. Rep.

246, 249.

Owning and caring for property and division of the

income from it is not ‘‘doing business.”” Business must be

actually done. So far as concerns the mining property, the

contracts disqualified respondents from ‘‘doing business.”’

The business was all done by the lessees. The petty

licenses to squatters and the two or three sales of burned

timber to save its value from destruction were of course

merely incidental and negligible. So were the sales of

land, which were trivial, incidental to ownership and made

under a contract antedating respondents’ ownership.

Sales, or receipts of principal, interest or rents, as in-

cidents of ownership, are not doing business.

Since the receipts of money under the mining con-

tracts represented merely a conversion of capital assets

without gain or profit, they were not ‘‘gross income.”

Respondents took and held the legal title, subject to the

outstanding contracts, pursuant to which they could re-

ceive, and anticipate receiving, nothing except the moneys

which should become payable thereunder. Even if the

contracts were not sales of the ore, it does not follow that

the receipts were income. Counsel here distinguished

English cases, and cited Caldwell v. Fulton, 31 Pa. St. 475;

Harlan v. Lehigh C. & N. Co., 35 Pa. St. 287; Citizens’ Gas

Co. v. Whitney, 232 Pa. St. 592, and many other Penn-

sylvania decisions, and Hook v. Garfield Coal Co., 112

Towa, 210; Wilson v. Youst, 43 W. Va. 826; Selvey v.

Grafton Coal Co., 72 W. Va. 680; Manning v. Frazier, 96

Illinois, 279. The contracts are analogous to executory

contracts of sale. Genet v. D. & H. Canal Co., 136 N. Y.

593; Browning v. Boswell, 215 Fed. Rep. 826; Kansas

Natural Gas Co. v. Board, 75 Kansas, 335.

The decisioris of the Minnesota Supreme Court on the

nature of such ‘‘mining leases” are not binding as a rule of

(ESN ee Re NETO Nee Sean EE

510 OCTOBER TERM, 1916.

Argument for Respondents. 242 U.S.

property or otherwise. All the cases cited to the con-

trary concerned private disputes in most instances gov-

erned by local laws or rules of property, and in none of

them was the construction of a federal statute involved.

The law in question is a federal taxing law which under the

Constitution must operate with uniformity to be valid,

and in applying it the federal courts must follow their own

judgment.

Gross income and gross receipts are different things.

There is no tax unless there are net profits. Flint v.

Stone-Tracy Co., 220 U. 8. 145. If the receipts from the

leases were income there would be no distinction under the

act between income and ‘‘property or invested capital.”

That proceeds of sales of capital are not income, see:

Stevens v. Hudson’s Bay Co., 101 L. T. Rep. 96; Secretary

of State for India v. Scoble, 89 L. T. Rep. 1; Baldwin

Locomotive Works v. McCoach, 215 Fed. Rep. 967, 969.

That -is capital which is owned by a taxpayer at the

time of the incidence of the tax, and to the extent of its

value at that time, money into which the property is

afterward converted, is not to be considered as income

which can form the basis of taxation.

The respondents were entitled to deduct the amount of

the royalties as ‘‘a reasonable allowance for depreciation

of property,” under the act. Omission to enter them in a

depreciation account was not material, and the Com-

missioner’s regulation to the contrary was an unlawful

extension of the act. The question of depreciation was one

of fact. Bailey v. Railroad Company, 106 U.S. 109. Asa

fact the capital value of the contracts, as it was when the

act took effect, was diminished by the amount of the

subsequent payments. This was ‘‘depreciation,”’ under

the act. See the Income Tax Law of September 8, 1916,

§§ 10 and 12, 39 Stat. 756.

Stratton’s Independence v. Howbert is consistent with the

foregoing propositions.

iia eeetintaiiet ne teeeneimmeccnmnsiile

VON BAUMBACH v. SARGENT LAND CO. 511

242 U.S. Opinion of the Court.

Mr. Justice Day delivered the opinion of the court.

These three cases were argued and submitted together

and involve practically the same facts. Suits were brought

by the corporations named in the United States District

Court for the District of Minnesota against the Collector

of Internal Revenue, to recover certain taxes, paid under

protest, assessed under the Corporation Tax Law of 1909,

36 Stat. 11, 112, for the years 1909, 1910 and 1911. The

judgments in the District Court were for the respondents

(207 Fed. Rep. 423), which judgments were affirmed in the

Circuit Court of Appeals. 219 Fed. Rep. 31.

In 1890, John 8. Pillsbury, George A. Pillsbury and

Charles A. Pillsbury, doing business together as John S.

Pillsbury & Company, were the owners of large tracts of

lands in northern Minnesota, which had been acquired for

the timber and from which the timber had been cut, being

valuable after such severance of the timber for the mineral

- deposits contained therein. In the year named, the Pills-

burys entered into an arrangement with John M. Long-

year and Russell M. Bennett, authorizing the latter two to

explore the lands for iron deposits. In 1892, Longyear

and Bennett having discovered valuable deposits of iron

ore, a half interest in something over ten thousand acres

of the lands was conveyed to them, the lands thereafter

being owned by the Pillsburys, John, George and Charles,

each an undivided sixth, and John M. Longyear and

Russell M. Bennett each an undivided fourth. In the

year 1901, the Pillsburys having died, these corporations

were formed under the laws of Minnesota. In 1906, the

ownership of these leased lands was vested in the three

corporations named as respondents in the proceedings.

As originally organized, the nature of the business was

stated to be ‘‘the buying, owning, exploring and develop-

ing, leasing, improving, selling and dealing in, lands,

tenements and hereditaments, and the doing of all things

512 OCTOBER TERM, 1916.

Opinion of the Court. 242 U.S.

necessary or incidental to the things above specified.”

In December, 1909, the articles of incorporation were

amended to read as follows: ‘‘The general purpose of the

corporation is to unite in one ownership the undivided

fractional interests of its various stockholders in lands,

tenements and hereditaments, and to own such property,

and, for the convenience of its stockholders, to receive,

and distribute to them, the proceeds of any disposition

of such property at such times, in such amounts, and

in such manner, as the board of directors may deter-

mine.”

All of the mining leases, hereinafter mentioned, with

the exception of a contract with the Van Buren Mining

Company, were executed before the organization of the

corporations. Each of these instruments provided that

the owners of the property demised to the lessees, exclu-

sively, all the lands covered by the descriptions for the

purpose of exploring for, mining and removing the mer-

chantable iron ore which might be found therein for and

during the period named, usually fifty years. The lessees —

were given exclusive right to occupy and control the

demised premises and to erect all necessary buildings,

structures and improvements thereon. Right was re-

served to the lessors to enter for the purpose of measuring

the amount of ore mined and removed and making ob-

servations of the operations in the mines. The lessees

agreed to pay, in most cases, twenty-five cents per ton for

all ore mined and removed, and to make such payments

monthly for ore mined and shipped during the preceding

month. The lessees agreed to mine and ship a specified

quantity of ore in each year, and, in default of this, to pay

the lessors for the minimum amount specified, and take

credit therefor and apply such sums upon ore mined and

shipped thereafter in excess of such minimum. The

lessees were to pay the taxes and to keep the property free

from encumbrances and liens. Right was reserved to

VON BAUMBACH »v. SARGENT LAND CO. 513

242 U.S. Opinion of the Court.

terminate the contract upon the failure of the lessees to

comply with the terms thereof.

The form of the leases is shown in Exhibits 15 and 16,

which were not in the printed record, owing to their

length, but copies of which, pursuant to stipulation, have

been sent to this court. An examination of Exhibit 16

shows that the lessees had the right to terminate and

surrender the lease by giving the lessors, or those having

their estate in the premises, sixty days’ written notice, and

executing sufficient conveyances releasing all interest and

right of the lessees in the premises with any improvements

thereon, and surrendering the same in good order and

condition, etc., and that thereupon all liability of the

lessees to taxes subsequently assessed on the demised

premises or for rent thereof thereafter to accrue, or royalty

on ores therefrom except on account of ores removed,

should cease and determine; the lessees to be liable for all

ores removed from the premises not theretofore paid

for, and to pay for the premises rent or royalty for the

year in which termination should be made, or the por-

tion thereof which should have expired, at the rate of

$12,500.00 per annum.

Since their organization the corporations have disposea

of certain lands and have also disposed of the stumpage

on some timber lands. Certain parcels were rented and

leased, and a village was allowed to use part of the land for

schoolhouse purposes, as well as another part for a public

park.

To insure the proper carrying on of the mining opera-

tions, the companies employed another corporation, en-

gaged in engineering and inspection of ore properties, to

provide supervision and inspection of the work upon the

respondents’ properties, for which the inspecting company

was paid from month to month, as statements were

rendered.

The companies were assessed upon their gross income,

enn) wean

for joint hearing on a day convenient to the court

at the next term.

These are suits brought by the above-named

respondents to recover taxes claimed to have been

erroneously collected under the provisions of the

Corporation-Tax Act. The question presented is

whether corporations, lessors in mining leases, are

liable to pay a corporation tax on the royalties

or rents received therefrom, under the provisions

of section 38 of the act of Congress of August 5,

1909, 36 Stat. 11, 112. The determination of

the question by this court will control the dis-

position of a number of cases where taxes were

collected under similar circumstances.

Opposing counsel concur in this motion.

JoHn W. Davis,

Solicitor General.

APRIL, 1916.