Petition for Writ of Certiorari — Lynch v. Alworth-Stephens Co.

Inthe Supreme Gourt of the Wnited States,

MarGcareT C. Lyncu, EXECUTRIX OF )

the Last Will and Testament of E. J.

Lynch, Deceased, petitioner, x

>No. ——.

v.

ALWORTH-STEPHENS COMPANY, RE-

spondent. ;

PETITION FOR WRIT OF CERTIORARI TO THE UNITED

STATES CIRCUIT COURT OF APPEALS FOR THE

EIGHTH CIRCUIT AND BRIEF IN SUPPORT THEREOF.

The Solicitor General, on behalf of Margaret C.

Lynch as executrix of the last will and testament of

E. J. Lynch, deceased, formerly Collector of Internal

Revenue for the District of Minnesota, prays that a

writ of certiorari issue to review the judgment of the

Circuit Court of Appeals for the Eighth Circuit

entered in the above case on November 12, 1923,

affirming the judgment of the District Court for the

District of Minnesota.

STATEMENT OF THE CASE.

This is an action instituted by the Alworth-Stephens

Company, a mining corporation, against E. J. Lynch

as Collector of Internal Revenue for the District of

Minnesota to recover back the sum of $21,045.91,

Federal income and excess-profits taxes paid for the

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year 1917, assessed and collected under the provisions

of the Revenue Act of 1916, as amended by the

Revenue Act of 1917. The District Court for the

District of Minnesota gave judgment for the plaintiff

in the sum of $20,322.89, and on appeal to the Circuit

Court of Appeals for the Eighth Circuit the judgment

was affirmed. The Collector of Internal Revenue,

E. J. Lynch, having died subsequently to the trial

of the case in the District Court, Margaret C. Lynch

as executrix was substituted as plaintiff in error in

the Circuit Court of Appeals.

During the year 1917 the plaintiff held leases of

two mines—namely, the Perkins Mine and the Hudson

Mine—in accordance with the terms hereinafter

stated.

It had a lease of the Perkins mine, with the right

to explore for and remove iron ore for 50 years, made

in 1908, by the terms of which it was under an obli-

gation to pay to the lessor, the owner of the mine,

30 cents for each ton of ore taken from the mine. It

subleased these rights in 1908 to one Lutes, who agreed

to pay 75 cents per ton for every ton taken from the

mine, and the mine was operated in 1917 by an as-

signee of Lutes under the lease to him, so that the

plaintiff received 45 cents per ton of the ore ex-

tracted during that year. It had a lease for 50

years of the Hudson mine, with the right to explore

for and remove iron ore, made by the fee owners

thereof in 1909, under which it was required to pay

to the lessors 30 cents per ton for the ore taken from

the mine. In 1909 it subleased these rights to the

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Syracuse Mining Company, which agreed by the

terms of the lease to pay to it 60 cents per ton for

every ton taken from the mine, and this mine was

operated under this lease in 1917.

The plaintiff’s entire income for 1917 was derived

from the rents and royalties received from the sub-

leases of the Perkins and Hudson mines. The

plaintiff instituted the present action to recover

back the sum of $21,045.91, claiming that it was

entitled, under the provisions of the statutes quoted

below, to a deduction for depletion of its ore properties

as representing a return of capital assets, and to

classification as a corporation having no invested

capital or not more than nominal capital.

The District Court found that the plaintiff had an

invested capital on January 1, 1917, of the sum of

$25,000, and held that such amount was more than a

nominal capital and that the plaintiff was taxable

under Section 201 of the Revenue Act of 1917; this

was affirmed by the Circuit Court of Appeals.

The District Court, however, held that under the

provisions of the statutes quoted below the plaintiff

was entitled to deduct from its total net royalties

received during 1917 the market value on March 1,

1913 (which it found to be 71.9 per cent of the total

of the receipts), of the plaintiff’s property interest in

the ore in the mines which was extracted during 1917.

The respondent maintains and contends that it is

entitled as lessee of the mines to a deduction for de-

pletion in figuring its net taxable income for the

year 1917.

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The petitioner, however, contends that under the

provisions of the statutes quoted below this right to

a deduction for depletion is restricted to the lessors

who were owners in fee of the mines to the exclusion

of the lessees.

QUESTION.

Is the lessee of mining property entitled to deduct

from gross income an allowance for ‘“depletion”’

under the provisions of the Revenue Act of 1916?

STATUTES INVOLVED.

REVENUE ACT OF 1916.!

(Act of September 8, 1916, 39 Stat. 756, 765-770.)

Src. 10. That there shall be levied, assessed,

collected, and paid annually upon the total

net income received in the preceding calendar

year from all sources by every corporation,

joint-stock company or association, or insur-

ance company, organized in the United States,

no matter how created or organized, but not

including partnerships, a tax of two per

centum upon such income; * * *.

Sec. 12(a). In the case of a corporation,

joint-stock company, or association, or insur-

ance company, organized in the United States,

such net income shall be ascertained by de-

ducting from the gross amount of its income

received within the year from all sources—

First. All the ordinary and necessary ex-

penses paid within the year in the mainte-

nance and operation of its business and

properties; * * *.

4 Bection 4 of the Revenue Act of 1917 imposed a tax of 4 per cent

in addition to that levied by Section 10 of the Revenue Act of 1916.

i)

Second. All losses actually sustained and

charged off within the year and not compen-

sated by insurance or otherwise, including a

reasonable allowance for the exhaustion, wear

and tear of property arising out of its use or

employment in the business or trade; (a) in

the case of oil and gas wells a reasonable

allowance for actual reduction in flow and

production to be ascertained not by the flush

flow but by the settled production of regular

flow; (b) in the case of mines a reasonable

allowance for depletion thereof not to exceed

the market value in the mine of the product

thereof which has been mined and sold during

the year for which the return and computation

are made, such reasonable allowance to be

made in the case of both (a) and (b) under

rules and regulations to be prescribed by the

Secretary of the Treasury. Provided, that

when the allowance authorized in (a) and (b)

shall equal the capital originally invested, or

in case of purchase made prior to March first,

nineteen hundred and thirteen, the fair market

value as of that date, no further allowance

shall be made; * * *,

Third. The amount of interest paid within

the year; * * *,

Fourth. Taxes paid within the year * * *,

REVENUE ACT OF 1917.

(Act of October 3, 1917, 40 Stat. 300, 302-307.)

Sec. 201. That in addition to the taxes

under existing law and under this act there

shall be levied, assessed, collected, and paid

——

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for each taxable year upon the income of

every corporation, partnership, or individual,

a tax (hereinafter in this title referred to as

the tax) equal to the following percentages of

the net income: (here follow the percent-

ages) * * *,

Sec. 203. That for the purposes of this

title the deduction shall be as follows, except

as otherwise in this title provided—

(a) In the case of a domestic corporation,

the sum of (1) an amount equal to the same

percentage of the invested capital for the

taxable year which the average amount of

the annual net income of the trade or business

during the prewar period was of the invested

capital for the prewar period (but not less

than seven or more than nine per centum of

the invested capital for the taxable year),

and (2) $3,000; * * *,

REASONS FOR GRANTING THE PETITION.

1. The construction of Section 12(a) of the Reve-

nue Act of 1916, allowing a deduction in the case

of mines of “a reasonable allowance for depletion”’

has never been directly passed upon by this court,

but in the case of Weiss, Collector, v. Mohawk Mining

Company, 264 Fed. 502, the Circuit Court of Appeals

for the Sixth Circuit held that a lessee of mining

property was not entitled to any allowance for

depletion under the provisions of the Revenue Act

of 1916, and this court denied a petition for cer-

tiorari, 254 U.S. 637.

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2. The Circuit Court of Appeals for the Eighth

Circuit in the case at bar has refused to follow the

rule laid down in the Mohawk Mining case, supra,

and the opinions of the two courts are in direct con-

flict. The opinion of the Circuit Court of Appeals

for the Eighth Circuit states:

Counsel cite and seem to rely upon the

opinion of the Circuit Court of Appeals of the

Sixth Circuit in Weiss v. Mohawk Mining

Company, 264 Fed. 502, in which that court

held that the lessee in that mining case was not

entitled to a reasonable allowance for deple-

tion of the value of its property right in the

royalties to accrue to it under the leases of the

mine. The opinion in the Weiss case has been

carefully read and studied, but, after careful

consideration, notwithstanding our great re-

spect for and deference to the judges who con-

curred in that opinion, it has not proved

persuasive.

3. In auditing thousands of returns of mining com-

panies under the provisions of the Revenue Act of

1916 the Department has followed the decision in

the Mohawk Mining case and has allowed depletion

only to the fee owner of mineral lands, and no deple-

tion to a lessee. If the rule laid down in the Eighth

Cireuit is sustained, refunds of approximately ten

million dollars will necessarily be made to lessees.

4. If the rule established bv the District Court and

affirmed by the Circuit Court of Appeals for the

Fighth Circuit that no income or profit on ore re-

moved is realized until the capital value is returned

ERAT TP RR aR RIES

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represents the correct rule, then the amount of re-

funds of taxes paid by lessees would amount to an

additional ten million dollars. And if the same rule

is also applied to lessors under the decision of the

Circuit Court of Appeals for the Eighth Circuit, then

there will be an additional refund of seven million

dollars.

5. In holding that the lessee of mining property

is entitled to depletion under the provisions of the

Revenue Act of 1916, the Circuit Court of Appeals

for the Eighth Circuit has utterly disregarded and

refused to follow the fundamental principles an-

nounced by this court in the cases of Stratton’s

Independence v. Howbert, 231 U. 5. 399; Stanton v.

Baltic Mining Company, 240 U. S$. 103; Von

Baumbach v. Sargent Land Company, 242 U.S. 503;

United States v. Biwabik Mining Company, 247 U.S.

116; Goldfield Consolidated Mines Co. v. Scott, 247 U.

S. 126; Doyle v. Mitchell Bros. Co., 247 U.S. 179.

Therefore, it is respectfully submitted that this

petition for a writ of certiorari to review the decree

of the Circuit Court of Appeals for the Eighth Circuit

should be granted.

JamMEs M. Breck,

Solicitor General.

g ey

BRIEF IN SUPPORT OF PETITION.

The decision of the Circuit Court of Appeals for

the Sixth Circuit in the case of Weiss v. Mohawk

Mining Company, 264 Fed. 502, and the decision of

the Circuit Court of Appeals for the Eighth Circuit

in the case at bar are diametrically opposed and can-

not be reconciled. Which rule is to be followed can

only be finally determined by this court.

The long prevailing rule and principle announced

by this court, which the Circuit Court of Appeals for

the Sixth Circuit followed in the case of Weiss v.

Mohawk Mining Company, is that the entire pro-

ceeds derived from mining operations constitute in-

come and profit without deduction for original cost

or capital invested. The income derived from min-

ing operations is distinguished by peculiar principles

and by special rules which have been recognized for

a long period of years by both the courts and legis-

lative bodies. These rules and principles are founded

upon the distinctive character of mining properties

and their particular method of operation.

These principles have been recognized by this

court in many cases, particularly Sératton’s Inde-

pendence v. Howbert, 231 U. 5. 399, at page 413.

This court has held that there is no inherent right

to a deduction for depletion.

Goldfield Consolidated Mines Co. v. Scott,

247 U.S. 126.

Stanton v. Baltic Mining Co., 240 U.S. 108.

Von Baumbach v. Sargent Land Co., 242

U.S. 503.

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Depletion as used in the Revenue Act of 1916

means an exhaustion of capital assets, and any

such exhaustion constitutes a loss to the fee owner

of the property, not to a lessee. The lessee loses

nothing. A lessee bargains with the fee owner to

mine out the mineral content of the land. The

land of the fee owner is thereby depleted, but no

depletion is suffered by the lessee as such. His

income is represented by the proceeds of the sale of

ore less expenses incurred. His object is to exhaust

the ore, and the exercise of this privilege is all that

he pays for. If, as in the case at bar, the- lessee

transfers all of his rights under lease to an operating

company, he transfers his privilege in consideration

of the payment of royalties. He transfers only the

right which he held as lessee. The amount received

as royalties represents his income. The operating

company exhausts the ore, and the land of the fee

owner alone is depleted by the amount of ore ex-

tracted and removed.

It has been repeatedly held by this court, and the

rule definitely established, that leases upon ore lands

in Minnesota are not conveyances of the ore in place

but are simply grants with the privilege to explore

for, mine, and remove the minerals from the land.

Stratton’s Independence v. Howbert, 231 U.

S. 399.

Stanton v. Baltic Mining Co., 240 U.S. 103.

Von Baumbach v. Sargent Land Co., 242 U.

S. 503.

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United States v. Biwabik Mining Co., 247

U.S. 116.

Goldfield Consolidaied Mines Co. v. Scott,

247 U.S. 126.

Doyle v. Mitchell Bros. Co., 247 U. S. 179.

Weiss v. Mohawk Mining Co., 264 Fed. 502.

In the case of United States v. Biwabik Mining

Company, 247 U. S. 116, it was held that the lease

involved was not to be construed as the conveyance

of the ore in place, although the latter could be

measured with substantial accuracy. The court

says at page 125:

The lessee takes from the property the ore

mined, paying for the privilege so much per

ton for each ton removed. He has this right

or privilege under the form of lease here in-

volved so long as he sees fit to hold the same

without exercising the privilege of cancella-

tion therein contained. He is, as we held in

the Sargent Land Co. Case, in no legal sense a

purchaser of ore in place.

In the case of Weiss, Collector, v. Mohawk Mining

Company, 264 Fed. 502, it was held the Mohawk

Mining Company because it was a lessee only was not

entitled to the allowance which it was admitted

would be rightful if it were the fee owner. The court

at page 505 uses the following language:

In United States v. Biwabik Co., 247 U.5.

116 (arising under the act of 1909), it was

ruled, after full consideration, that under a

lease, practically identical with the Mohawk

lease now involved, the nature of the interest

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held by the lessee was not such as to permit it

to claim the allowance, but that the contin-

gencies which attended the character of the

lessee’s interest barred it from claiming that

its capital assets had been diminished. It is

true that the question whether the mining of

ore could be considered depreciation in any

event was underlying, and that this question

has been completely removed by the amend-

ment of 1916; but the Supreme Court did not

rest its conclusion at all upon the definition of

depreciation.

The court further states that it can conceive no

substantial distinction as applied to a mine between

the depreciation as sought by mine owners under the

earlier act and that depletion which was expressly

allowed by the amendment of 1916. On petition for

rehearing the court says, at page 506:

We cannot read the decisions of the Supreme

Court as having determined that the exhaus-

tion of ore reserve is so inherently a business

loss, rather than an impairment of capital,

that a statutory grant of the right to deduct

for depletion on that account will reach a case

which has been adjudged not to involve the

diminution of capital assets.

A petition for a writ of certiorari in the ji/ohawk

Company case was denied. (254 U. 8. 637.)

This court has approved and applied under the

terms of the Revenue Act of 1916, Section 12 (a),

which governs both the Mohawk Company case and

the instant case, the same rule regarding the claim of

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a lessee of mines for a deduction on account of impair-

ment of capital assets which it had previously applied

under earlier revenue acts.

The Department has consistently followed the

rules laid down by this court and by the Circuit

Court of Appeals for the Sixth Circuit in the case of

Weiss v. Mohawk Mining Co., supra, and thousands

of cases of mining companies have been settled and

taxes paid under the rule of the Sixth Circuit. The

decision of the Circuit Court of Appeals for the

Eighth Circuit in the case at bar disregards the prin-

ciples heretofore laid down by this court and refuses

to follow the rule laid down by the Sixth Circuit.

The Eighth Circuit holds, first, ‘that the Revenue

Act of 1916 grants to the lessor, the lessee, and the

fee owner, and to other corporations who were on

March 1, 1913, the owners of valuable property

rights and interest in mines, a reasonable allowance

for depletion, and, second, holds that no net in-

come is received by a lessee or lessor until the

capital value as of March 1, 1913, has been repaid.

If the rule now announced by the Circuit Court of

Appeals for the Eighth Circuit is correct, then the

principles laid down by this court in many adjudi-

cated cases are fundamentally wrong. If this court

accepts the rule of the Eighth Circuit it must neces-

sarily overrule its prior adjudication.

It is respectfully submitted that the rule in the

Sixth Circuit, which follows the prior cases decided

by this court, is correct, that the decision in the

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Eighth Circuit is erroneous, and that the petition for

certiorari should be granted to finally establish the

rule to be followed.

JAMES M. Beck,

Solicitor General.

FEBRUARY, 1924.

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