Petitioners Brief — Reinecke v. Spalding

Office Supreme: Court, U.

FLD

NOV 28 i999

CLERK

FILE COPY . : . SF pues euwone engeu

No. 69.

wt - = .

She Sapene Gourta he lnited sins

7 - OcrosER Tena, 1929

MABEL ‘a:: ieareaare: Ciersones oF INTERNAL

~ REVENUE FOR THE First Disraic OF ILLINOIS,

PETITIONER :

~ . v. . 3 ‘ j

“Euvpora Hutt Spaine -

ON WRIT OF CERTIORARI TO THH UNITED-STATES CIRCUIT

COURT OF APPEALS FOR THE SEVENTH CIRCUIT

BRIEF FOR THE PETITIONER

PETE TNS tee RIOR N ESSE CE A TR MLLER De

Temenos) DUCGONTEG og eb icnunp oe aeieeeinwen

‘Statutes and regulations involved________ i

ROUEN nna repscieim men sh epten en comets put mio my

= ‘Specification of error to be urged__-__-..._---------------.---

% Rennes -O8 Creare. oso cl anon neat knee

Argument: é;

I. The taxpayer had the burden of establishing the facts

ee showing that she was entitled to the allowance for

a depletion which the Commissioner had disallowed__

ue

If. The taxpayer ‘failed to establish the value of her

interest in the mines as of March 1, 1913_____-___-

Bs: Ill. The only proper basis for computing the allowance for

fi depletion was the value of the taxpayer’s interest

= in the mines as of March 1, 1913____-.--__-________

¥ IV. The allowance for depletion should be computed by

BS determining the percentage of the whole reserve

} a which was withdrawn and paid for during the tax-

s able year and taking this same percentage of the

Ag value of the taxpfyer’s interest in the mine on

a Weis Sa eee

i ERS Lae OO PE ONE a SED TORN PE NI SONS

Appendix A. Statutes and regulations _.._..--___-_---_-------

B. Supplementary discussion of opinion of the Circuit

Court of Appeals_______-_- Reve

C. Extract from the record in McHale v. Hull_____---

CITATIONS

Cases:

Boske v. Comingore, 177 U. S. 459____-.----.-------------

Botany Mills vy. United States, 278 U. S. 282_-.-.--.---_-_-.

Ithaca Trust Co. v. United States, 279 U. S, 151_-_---_-_-

Lynch vy. Aliworth-Stephens Co., 267 U. S, 364-------------

a New Creek Co. v. Lederer, 295 Fed. 433; certiorari denied,

.. 265 U. 8. 581.__-- sss sale SAAN Sista tei Oceans ginseng f

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

Stratton’s Independence v. Howbert, 231 U. 8. 399_____-_--

United States y. Anderson, 269 U. S, 422__---------------

United States v. Birdsall, 233 U. S. 223_------------------

United States v. Morehead, 243 U. S. GO7_-_-- Se RRR ET ON Us

Weise v. Weiner, 279 U. S. 388._..---..--------.--.._-_.

81142—-29——-1 (YD

United States v. Ludey, 274 U. 8, 295. ---------.- 15, 16,

teu oun

12

17

24

17

17

bai

Statutes:

Revenue act of 1916, c. 463, sec. 5(a)(8), 39 Stat. 756,

759 12, 24

Revenue act of 1917, c. 684, 40 Stat. 300 24

Revenue act of 1918, c. 18, sec. 214(a) (10), 40 Stat. 1057, -

1067 12, 25

Treasury Regulations:

No. 33 (revised), art. 172 32

No. 45 (1920 ed.) —

Art. 201 26

Art. 204 27

Art. 206 14, 28

Art. 210 82

Miscellaneous:

Grimes & Craigue, Principles of Valuation, p. 224......-. 86

Saliers, Depreciation, Principles and Application, pp. 467-

468 87

Inthe Supreme Court of the Bnited State

OctoBer TERM, 1929

No. 59

MaBeEL G. REINECKE, CoLLECTOR OF INTERNAL REvE- °

nue for the First District of Illinois, petitioner

v.

Evpora Hui Spatpina

ON WRIT OF CERTIORARI TO THE UNITED STATES CIRCUIT

COURT OF APPEALS FOR THE SEVENTH OIRCUIT

BRIEF FOR THE PETITIONER

OPINIONS BELOW

The District Court did not write an opinion. Its

reasons for directing a verdict in favor of the re-

spondent appear on page 44 of the Record. The

opinion of the Circuit Court of Appeals (R. 159)

is reported in 30 F. (2d) 369.

JURISDICTION

The judgment of the Circuit Court of Appeals

was entered on January 2, 1929. (R. 159.) Peti-

tion for certiorari was filed March 30, 1929. Oer-

tiorari was granted April 29, 1929. (R. 165.)

(1)

2

The jurisdiction of this Court rests on Section

240 (a) of the Judicial Code, as amended by the

Act of February 13, 1925.

QUESTION PRESENTED

The question in this case is whether in computing

income taxes for 1917 and 1918 a taxpayer who re-

ceived royalties under leases of mining lands made

prior to March 1, 1913, may compute an allowance

for the depletion of her interests in mines on the

basis of the March 1, 1913, value in the ground of

the specific ore extracted during the years for which

the computation is made, wholly disregarding the

March 1, 1913, value of the taxpayer’s interests in

the mines and the relation between that value and

the total reserves.

STATUTES AND REGULATIONS INVOLVED

The statutes and regulations involved are in-

cluded in an appendix to this brief, pp. 24-34, infra.

STATEMENT

The taxpayer is the owner of an undivided one-

sixth interest in certain lands underlaid with iron

ore, which prior to March 1, 1913, she and her eo-

owners had leased to various lessees for the purpose

of extracting or mining, taking out, and removing

and shipping therefrom the merchantable ore upon

royalties at the rate of twenty-five cents per ton.

(R. 63, 75, 83, 92, 100, 108, 116.) Under these

leases the taxpayer received as royalties the sum

of $260,072.30 during the year 1917, and the sum of

3

$219,940.43 during the year 1918. (R.22.) Inher

imeome-tax return for these years she reported the

amounts so received as income and deducted as rea-

sonable allowances for depletion the same amounts,

thus reporting as taxable income from rents and

royalties ‘“‘none.’’ (Plaintiff’s Exhibits A and B,

R. 46, 54.) Upon the filing of these returns the

Commissioner notified the taxpayer (R. 128) :

Your method of deducting from gross in-

come the entire amount received as royalty

from iron mines as depletion is not ap-

proved by this office. The correct amount

to be deducted for depletion, based upon the

unit cost per ton of mineral reserves, as of

March 1, 1913, as determined by the Valua-

tion Engineers of this Department is shown

as follows: * * *

cee Le eS IS Me Te $02, 194. 92 (R. 128)

ee fC | Re ee See 77, 968.20 (R. 141)

Later, upon reconsideration, the Commissioner

increased the depletion for 1917 to $99,561.20 (R.

139), and for 1918 to $84,979.55 (R. 143).

The taxpayer paid under protest the additional

taxes assessed by reason of the changes made in

the depletion allowances and filed claims for re-

fund. Her claim for the year 1917 alleges that

the additional tax is erroneous because (R. 145)—

Tax as assessed is based upon income re-

ceived from royalties from iron ore mines.

Depletion amounting to $99,561.20 was

allowed to taxpayer, whereas depletion

amounting to $203,510.86 should be allowed.

4

The latter amount is the present worth of

the ore mined in 1917, as of March 1, 1913,

and is arrived at by discounting the amount

received in 1917 at 5% to March 1, 1913.

The claim for 1918 was predicated upon the same

alleged error. (R. 148.) Both of these claims

were rejected (R. 149, 150), whereupon the tax-

payer brought this action in the United States Dis-

trict Court for the Northern District of Illinois.

The record does not clearly show the method used

by the Commissioner in computing the allowances,

but the taxpayer’s method does clearly appear.

The Government contended in the courts below

that the method used by the taxpayer is improper

and that the proper allowance for depletion in each

year in respect to each mine must, in accordance

with the statutes and regulations, be determined by

taking as a basis the March 1, 1913, value of the

taxpayer’s interest in that mine. The Government

further contended that this value should be multi-

plied by the percentage of the whole reserve which

was withdrawn and paid for during the year for

which the allowance is computed, and that therefore

the proper allowance could not be computed unless

the March 1, 1913, value of the taxpayer’s interest

in the mines and the reserve tonnage were shown,

and, that as the taxpayer failed to show these

factors, she could not recover. (R. 17, 154.)

The case was tried in the District Court before a

jury. At the close of the evidence the Government

5

moved for a directed verdict (R. 17) on the ground

there was not sufficient evidence to entitle the tax-

payer to recover and that the verdict must be for

the Government because—

1, There is no legally sufficient evidence

to show the fair market value as of March 1,

1913, of the plaintiff’s interest in each of the

mines involve in this action.

2. There is no legally sufficient evidence

to show the tonnage known or estimated re-

maining in the respective mines as of De-

cember 31, 1916, December 31, 1917, Decem-

ber 31, 1918, and December 31, 1919, respee-

tively.

3. The undisputed evidence shows that

the method for calculating depletion allow-

ance used by the plaintiff does not result in

reasonable allowance.

4. The undisputed evidence shows that

the method of calculating depletion allow-

ance used by the plaintiff is not in com-

pliance with the regulations of the Commis-

sion of Internal Revenue duly promulgated.

5. The undisputed evidence shows that

the allowances computed by the plaintiff are

not a percentage of his capital invested equal

to the percentage of the whole mineral con-

tent withdrawn during the year, and are

not a percentage of his capital investment

equal to the percentage of the unpaid royal-

ties paid during the year for which the caleu-

lation is made.

6

The taxpayer also moved for a directed verdict.

(R. 18.) The court granted the taxpayer’s motion

and denied the Government’s motion. (R. 44.) To

these rulings exceptions were duly taken and an

appeal to the Cireuit Court of Appeals for the

Seventh Circuit was prosecuted. The errors as-

signed in that court are found on pages 154-155

of the Record.

That court affirmed the judgment of the District

Court. (R. 163.) It held that the proper allowance

for depletion was the market value on March 1, 1915,

of the tonnage in the mine of the product mined dur-

ing the year for which the return is made, ‘‘less the

interest carrying charge of 5%’’ and that since the

plaintiff had established that market value and this

charge, she was entitled to the deduction claimed by

her in her amended declaration. (R. 163.) The

opinion says (R. 160) :

The sole controversy is over the correctness

of the Government’s method of arriving at

the value of the iron ore in the ground on

March 1, 1913, a matter not covered by the

revenue acts in question, nor by any regula-

tion of the Treasury Department.

We contend that these premises are incorrect.

The opinion of the court also makes certain state-

ments as to the Government’s methods which, we

submit, are not supported either by the reeord or by

the facts. (See pp. 34-38, infra.)

7

SPECIFICATION OF ERROR TO BE URGED

The Cireuit Court of Appeals erred in holding

that the taxpayer was entitled under Section 214

(a) (10) of the Revenue Act of 1918 and under See-

tion 5 (a) Eighth of the Revenue Act of 1916 to com-

pute the reasonable allowance for depletion upon

the basis of the fair cash market value in the mine of

the tonnage mined during the taxable year, and to

deduct this value less the “interest carrying

charge,’ said to be five per cent per annum from

March 1, 1913. (R. 163.)

SUMMARY OF ARGUMENT

1, The taxpayer had the burden of establishing

the facts showing that she was entitled to the allow-

ance for depletion which the Commissioner had

disallowed.

2. The taxpayer failed to establish the value of

her interest in the mines as of March 1, 1913. Al-

though several witnesses testified that the value of

the ore in place in the mines was 25 cents per ton

on March 1, 1913, every one of these witnesses ad-

mitted that the question as to the value of the tax-

payer’s interest in the ore was an entirely different

matter and no witness testified as to this matter.

Nevertheless, the court below proceeded upon the

theory that her interest on March 1, 1913, in the ore

was valued at the rate of 25 cents per ton.

3. The only proper basis for computing the al-

lowance for depletion was the value of the tax-

payer’s interest in the mines on March 1, 1913.

81142—29-___2

8

The taxpayer’s only interest in the properties on

March 1, 1913, was that of lessor. The Revenue

Acts of 1917 and 1918 and the regulations made in

pursuance of the authority granted by them pro-

vide in effect that the basis for computing the al-

lowance for depletion in the case of a lessor of min-

ing properties is the value as of March 1, 1913, of

the royalties to be expected under the terms of the

lease in effect on that date, and that the allowance

must represent the reduction of capital assets of the

taxpayer during the year. The regulations are

based upon correct principles and have the force

and effect of law.

4. The allowance for depletion should be com-

puted by determining the percentage of the whole

reserve which was withdrawn and paid for during

the taxable year and taking this same percentage

of the value of the taxpayer’s interest in the mine

on March 1, 1913. This is required by correct

principles of depletion and the specific provisions

of the regulations. It is also in accordance with

the customary practice in the mining industry, ac-

cording to the uncontradicted testimony in this

ease. The courts below, however, followed a

method which was not based upon the March 1, 1913,

value of the taxpayer’s interest in the property and

a method which results in a depletion allowance hav-

ing no necessary relation to that percentage.

9

ARGUMENT

I

THE TAXPAYER HAD THE BURDEN OF ESTABLISHING THE

FACTS SHOWING THAT SHE WAS ENTITLED TO THE AL.

LOWANCE FOR DEPLETION WHICH THE COMMISSIONER

HAD DISALLOWED

This burden rests upon the taxpayer in an action

brought by him to recover taxes alleged to have

been illegally collected. In Botany Mills v. United

States, 278 U. S. 282, such an action was brought

by a taxpayer which was a corporation. It con-

tended that in the computation of its income taxes

it was entitled to a large deduction on account of

certain payments made to its directors, on the

ground that these payments constituted a part of its

“ordinary and necessary expenses’’ in the mainte-

nance and operation of its business and property.

This Court said (pp. 289-290) :

And in this suit the burden of establishing

that fact rested upon it, in order to show that

it was entitled to the deduction which the

Commissioner had disallowed, and that the

additional tax was to that extent illegally

assessed.

See also, to the same effect, United States y. An-

derson, 269 U. S. 422, 443.

II

THE TAXPAYER FAILED TO ESTABLISH THE VALUE OF HER

INTEREST IN THE MINES AS OF MARCH 1, 1913

If, as we contend, the only proper basis for com-

puting the allowance for depletion was the value

10

of the taxpayer’s interest in the mines as of March

1, 1913, the plaintiff must be denied recovery, as

she failed to show that value. Although she put on

the stand various witnesses who testified that the

March 1, 1913, value of the ore in place in the mines

was twenty-five cents a ton, every one of these wit-

nesses admitted that the question as to the value

of the taxpayer’s interest in each ton of ore was an

entirely different matter, and no witness testified as

to this matter. Thus the following appears in the

testimony of Savage (R. 24):

Q. You do not mean by that that Mrs.

Spalding’s interest in that ton of ore was

worth at least 25 cents, do you?

* * * * *

A. That question is based upon Mrs.

Spalding’s one-sixth ownership of a lease at

25 cents per ton. That question is an en-

tirely different one from the one asked me

by Mr. Zane. It would require a good deal

of calculation and certain assumptions as to

how fast that ore would be shipped. - Then

it would require discounting against those

assumptions to present value. That calcula-

tion would take time, and I can not answer

that without working it out.

And the witness Keith testified (R. 26) :

Mrs. Spalding’s interest in a ton of ore

was not necessarily as of March 1, 1913, of

the fair market value of over 25c. a ton.

In testifying as to the value of a ton of ore

I was not speaking of Mrs. Spalding’s inter-

11

est, or of any one’s interest. I was speaking

of the value of a ton of ore regardless of

ownership. I do not know of my own knowl-

edge what Mrs. Spalding’s interest of a ton

of ore was as of March 1, 1913.

Ives, the third and last witness on the question

of value, testified (R. 28):

I do not know what the value of Mrs.

Spalding’s interest in any ton of ore would

be.

The Cireuit Court of Appeals proceeded upon

the theory that the taxpayer’s interest on March 1,

1913, in the ore was valued at the rate of 25 cents

per ton. With respect to this the court said (R.

163) :

It seems clear that the ore mined in 1916

[1917] was worth to plaintiff 25 cents per

ton, that that price continued [contained ]

two elements, mine depletion and profit, and

that the way of arriving at the profit was to

take the fair cash market value on March 1,

1913, of the tonnage mined in 1916 [1917]

(which was shown to be 25 cents per ton)

less the interest carrying charge of 5% from

March 1, 1913, to 1916 [1917].

This conclusion was based upon the evidence that

the ore at all times on and after March 1, 1913, had

a market value in the ground untouched and un-

extracted above 25 cents per ton. (R. 23, 25, 26,

27.) This testimony, however, had no relation to

the taxpayer’s interest or to any distinct interest.

12

IIT

THE ONLY PROPER BASIS FOR COMPUTING THE ALLOW-

ANCE FOR DEPLETION WAS THE VALUE OF THE TAX-

PAYER’S INTEREST IN THE MINES AS OF MARCH 1, 1913.

On March 1, 1913, the taxpayer did not have the

right to extract any ore from any of the mines.

Her interest in the properties was merely that of

lessor; her rights were merely to receive the royal-

ties stipulated in the leases and to obtain posses-

sion of the property on the termination of the

leases.

The Revenue Act of 1916 (pp. 2425, infra)

allowed a taxpayer deriving income from 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 * * *

under rules and regulations to be pre-

scribed by the Secretary of the Treasury:

Provided, That when the allowances au-

thorized * * * shall equal the capital

originally invested, or in case of purchase

prior to March first, nineteen hundred and

thirteen, the fair market value as of that

date, no further allowance shall be made.

The Revenue Act of 1918 (pp. 25-26, infra)

allowed such a taxpayer—

areasonable allowancefordepletion * * *

according to the peculiar conditions in each

ease, based upon cost including cost of devel-

13

opment not otherwise deducted: Provided,

That in the case of such properties acquired

prior to March 1, 1913, the fair market value

of the property (or the taxpayer’s interest

therein) on that date shall be taken in lieu

of cost up to that date: * * * such rea-

sonable allowance in all the above eases to

be made under rules and regulations to be

prescribed by the Commissioner with the ap-

proval of the Secretary. In the case of

leases the deductions allowed by this para-

graph shall be equitably apportioned between

the lessor and lessee.

There is nothing in either of these statutes indi-

eating that a lessor of mines could base an allow-

ance for depletion on anything except his own inter-

est in the property (as distinguished from all of

the interests in the property). The 1918 Act pre-

scribes as the basis for computing the allowance the

taxpayer’s interest in the property, and we submit

that it is not reasonable to construe the 1916 Act in

any other way.

The method of computing the allowance adopted

by the taxpayer in the instant case finds no support

in the regulations governing the collection of the

tax for 1917 (pp. 32-34, infra), but these indicate

that the basis for allowance is the capital interest

of the taxpayer in the property on March 1, 1913.

The regulations under the 1918 Act (pp. 26-32,

infra) contemplate that the basis for computing the

allowance in the case of a lessor is “‘the value of his

14

equity in the spe oa at the basic date,’’ and pro-

vide that—

The value of a lessor’s equity in a mineral

property under lease March 1, 1913, for the

entire operating life of the mineral deposits

is the value as of March 1, 1913, of the royal-

ties and other payments to be expected under

the terms of the lease in effect on that date.

Obviously the value of such an equity would not

be the aggregate sum of all of the royalties to be

collected over a long term of years, but would be

the market value on March 1, 1913, of the lessor’s

right to the royalties. Article 206 of the regula-

tions under the 1918 Act provides (p. 28, infra)

that the value which is the basis for depreciation

must be determined—

in the light of the conditions and circum-

stances known at that date [March 1, 1913]

* * *, The value sought should be that

established assuming a transfer between a

willing seller and a willing buyer as of that

particular date.

That this method of determining value is a cor-

rect one is demonstrated by the opinion of this

Court in Ithaca Trust Co. v. United States, 279

U.S. 151, 155.

Although the provisions of, and the regulations

under, the earlier Act are not as specific as the pro-

visions of, and the regulations under, the Act of

1918, it seems clear that the depletion allowance

under the earlier Act and regulations should be

15

based upon the March 1, 1913, value of the plain-

tiff’s interests. See United States v. Ludey, 274

U.S. 295; New Creek Co. v. Lederer, 295 Fed. 433

(certiorari denied 265 U. 8. 581). In Lynch v.

Alworth-Stephens Co., 267 U. 8. 364, this Court

held that a lessee of a mine was entitled to an allow-

ance for depletion in its income tax for the year

1917, and said (pp. 369, 371) :

The interest of respondent under its leases

in the mines being property, its right to de-

duct a reasonable allowance for exhaustion

of such property, if there be any, during the

taxable year results from the plain terms of

the statute, such deduction, since the prop-

erty is an interest in mines, to be limited to

the amount of the exhaustion of respondent’s

interest caused by the depletion of the mines

during the taxable year. * * * The de-

duction for depletion in the case of mines

is a special application of the general

rule of the statute allowing a deduction for

exhaustion of property. While respondent

does not own the ore deposits, its right to

mine and remove the ore and reduce it to

possession and ownership is property within

the meaning of the general provision.

Obviously, as the process goes on, this prop-

erty interest of the lessee in the mines is

lessened from year to year, as the owner’s

property interest in the same mines is like-

wise lessened. There is an exhaustion of

property in the one case as in the other;

and the extent of it, with the consequent de-

81142—29—__3

- ~ wag

16

duction to be made, in each case is to be

arrived at in the same way, namely, by de-

termining the aggregate amount of the de-

pletion of the mines in which the several

interests inhere, based upon the market

value of the product, and allocating that

amount in proportion to the interest of each

severally considered. (Italics ours.)

The allowance must represent the reduction of

capital assets of the taxpayer during the year.

See regulations, Articles 201, 172, pp. 26-27, 32,

infra. This, we submit, is the principle underlying

the decision in United States v. Ludey, supra, in

which the Court said (274 U. S. at p. 302):

The depletion charge permitted as a de-

duetion from the gross income in determin-

ing the taxable income of mines for any year

represents the reduction in the mineral con-

tents of the reserves from which the product

is taken. The reserves are recognized as

wasting assets. The depletion effected by

operation is likened to the using up of raw

material in making the product of a manu-

facturing éstablishmert. As the cost of the

raw material must be deducted from the gross

income before the net income can be deter-

mined, so the estimated cost of the part of

the reserve used up is allowed. The fact

that the reserve is hidden from sight pre-

sents difficulties in making an estimate of

the amount of the deposits. The actual

quantity can rarely be measured. It must

be approximated. And because the quantity

originally in the reserve is not actually

17

known, the percentage of the whole with-

drawn in any year, and hence the appropri-

ate depletion charge, is necessarily a rough

estimate. But Congress concluded, in the

light of experience, that it was better to act

upon a rough estimate than to ignore the

fact of depletion.

See also Weiss v. Weiner, 279 U. 8. 333.

The Ludey case and the New Creek Co. case,

supra, also show that the regulations in question are

based upon correct principles. These regulations

were promulgated, not as an interpretation of the

law, but as a complement to it under express au-

thority granted by the Revenue Acts, and hence

have the force and effect of law. Regulations so

adopted should not be disregarded or departed from

unless plainly inconsistent with law. Boske v.

Comingore, 177 U. 8. 459; United States v. Bird-

sall, 233 U. 8. 223; United States v. Morehead, 243

U.S. 607.

It is well established that only such deductions

for depletion as are authorized by statute may be

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

103.

IV

THE ALLOWANCE FOR DEI’LETION SHOULD BE COMPUTED

BY DETERMINING THE PERCENTAGE OF THE WHOLE

RESERVE WHICH WAS WITHDRAWN AND PAID FOR DUR-

ING THE TAXABLE YEAR AND TAKING THIS SAME PER-

CENTAGE OF THE VALUE OF THE TAXPAYER'S INTEREST

IN THE MINE ON MARCH 1, 1913

Much of the criticism directed by the Circuit

Court of Appeals at the Commissioner’s determina-

18

tion was based upon an erroneous conception of

what was actually done. See pp. 34-38, infra.

At the trial the Government took the position

that the method used by the Commissioner was im-

material (R. 30) and the record does not show ex-

actly how the computa*ion was made. The District

Court said that it was conceded at the argument that

the record in the case “‘is for all purposes of this

motion, the same record, or, rather, substantially

the same record as the record’’ in McHale v. Hull.

(R. 44.) The Cireuit Court of Appeals stated that

‘The leases, for iron ore bearing lands, in this case,

were involved in McHale v. Hull, 16 Fed. (2d) 781,

and were made by appellee in that case and by plain-

tiff (appellee) here, anc others, as lessors.’’ (R.

159.)

Extracts from the agreed statement of facts in

McHale v. Hull, showing how the depletion allow-

ances were computed, appear in Appendix C at the

end of this brief.

If, as we have contended above, the burden was

upon the taxpayer to show that she was entitled to

the allowance for depletion which the Commissioner

had disallowed, the position taken by the Govern-

ment in the court below was correct, and for pur-

poses of the decision of the instant case it would

seem unnecessary to discuss the correct theory.

Nevertheless, it appears to us pertinent to point out

the correct method and to demonstrate that the

principles adopted by the court below were at

variance with this method.

_—

19

The deductions allowed on account of the deple-

tion of mines are intended to return to the taxpayer

his capital invested in the mines. United States v.

Ludey, 274 U. 8. 295, supra; Weiss v. Weiner, 279

U. 8. 333, supra. As this Court said in Stratton’s

Independence v. Howbert, 231 U. 8. 399, 421, the

amount of depreciation is to be “determined not

upon the basis of latent and occult intrinsic values,

but upon considerations that affect market value

and have their influence upon men of affairs

charged with the management of the business and

accounting of corporations that are organized for

profit and are engaged in business for purposes of

profit.’’

The capital investment should be returned in

step with the exhaustion of the physical property,

that is to say, the depletion allowed with respect to

each ton of ore mined and sold should be the same

proportion of the capital invested as that ton is of

the total reserves in which that capital is invested.

See United States v. Ludey, 274 U. 8. 295 (pp.

16-17, supra).

In order to apply the principles just stated, it

is necessary to obtain the value on March 1, 1913, of

the taxpayer’s expected royalties. To value these, -

resort should be had to a discount factor in accord-

ance with the sinking fund method for valuing

equal amounts of annual income. If the reversion is

valuable, the value of this should be included, but if

it is contemplated that the whole value of the land

will be exhausted during the leases, nothing need be

20

added for this interest. When the entire value of

the taxpayer’s interest has been ascertained, the

value of the taxpayer’s interest in a single unit com-

prised within the ore deposit should be determined

in accordance with the regulations by dividing the

value of the whole by the number of units. The

quotient thus obtained represents the amount of

capital applicable to each unit. When multiplied

by the number of units extracted in any one year,

the product will be the amount which will constitute

an allowable deduction from the gross income of

that year on aecount of depletion. Article 210, p.

32, infra; Article 172, p. 33, infra.

The method thus provides for the return of the

capital investment in step with the exhaustion of

the ore bodies. The calculation results in a deple-

tion figure which, when deducted from the total roy-

alties received during the year, shows the amount

of taxable profit over the original capital.

The taxpayer in this case did not show, and does

not seem to contend, that the Commissioner did not

compute the depletion according to this method.

There was uncontradicted testimony of a quali-

fied consulting mining engineer that in figuring de-

pletion in the mining industry, it is the eustom

to take the value of the owner’s interest in the mine

‘on the basie date, to divide that value by the tonnage

to get a factor to be used for depletion, and to figure

the depletion for any year by multiplying that fac-

tor by the number of tons extracted in that year;

and that without the value of the owner’s interest on

21 .

the basie date and an estimate of the ore reserve it

is impossible to determine a proper allowance for-

depletion. (R.40-41.) The same witness also testi-

fied, without contradiction, that the unit of deple-

tion depends upon the proportion of the total re-

serve in the mine which is extracted during the.

year. (R. 41-42.) All of this testimony the courts.

below disregarded.

The Cireuit Court of Appeals assumed that re-

spondent owned the ore in place on March 1, 1913,

and held that its intrinsic value, determined by

reference to events occurring thereafter and conse-

quently unknown on Mareh 1, 1913, was her eapital

and that she is entitled to deduct that value as the

measure of depletion This method entirely disre-

gards the extent of the mineral reserve on March 1,

1913, and gives no weight to the portion of the.

reserve which was exhausted in each taxable year.

It permits an allowance which may result in the

return of the taxpayer’s entire capital prior to the

exhaustion of the mine, or it may result in her never-

receiving tax-free her whole capital investment.

Only through a coincidence can it result in her re-

ceiving back the last of her capital simultaneously

with the exhaustion of the last of the ore. This is

so because this method depends wholly upon the

element of time and attributes to a ton of ore mined

in one year a greater capital value than it attributes

to a ton mined in a subsequent year. This is er-

roneous because a ton mined in 1917 is the same

proportion of the total tonnage in the mine on

22

March 1, 1913, as is another ton of ore mined in

1918.

Several mines were involved, and yet the Circuit

Court of Appeals applied a common rate of de-

pletion to each. In United States v. Ludey, 274

U. S. 295, supra, this Court indicated the necessity

of a separate rate for each property. It was there

said (p. 304):

The deduction allowable in the several years

for each of the properties is not found.

It can not be that each mine contained the same

amount of mineral ore and that each mine suffered

annual exhaustion in the same proportion. If

these factors are to be disregarded, as the Circuit

Court of Appeals indicated, then the term ‘“‘deple-

tion’’ becomes a misnomer.

If the taxpayer’s interest in each ton of ore on

March 1, 1913, was 25 cents, and if she received 25

cents for it in the taxable years, it is not clear upon

what basis the Circuit Court of Appeals applied a

5% interest rate to determine the depletion. If

she had a capital investment of 25 cents in each ton

of ore she should logically demand a deduction in

the same amount on account of depletion, thus dis-

regarding any element of profit. Without some

lear reason for applying a 5% interest rate, the

method adopted in this case seems to require a de-

pletion allowance similar to that which this Court

has already characterized as quite inadmissable.

Stratton’s Independence v. Howbert, 231 U. 8. 399,

supra.

From the foregoing it appears that the Circuit

Court of Appeals has approved a method of deple-

tion which is not based upon the March 1, 1913,

value of respondent’s interest in the whole mineral

reserve and a method which results in a depletion

allowance having no necessary relation to the ex-

haustion of her interest. We submit that the stat-

utes, regulations, and opinions of this Court re-

quire that these factors be taken into account.

Discussion of some subsidiary matters as to-

which we contend the court below was mistaken is

inserted in Appendix B, pp. 34-38, infra.

CONCLUSION

For the reasons stated, we respectfully submit

that the judgment of the court below should be:

reversed.

v CuaRLES E, Huaues, Jr.,

Solicitor General.

Vv G. A. Younaguist,

Assistant Attorney General.

CLaubE R. Branou,

Y SEWALL Key,

/ J. Louis Monakcu,

Special Assistants to the Attorney General.

NovEeMBER, 1929.

APPENDIX A

STATUTES AND REGULATIONS

As this action is brought to recover taxes for two

years, the provisions of two Acts are involved.

Taxes for the year 1917 are to be computed under

the Revenue Act of 1917, c¢. 63, 40 Stat. 300, and

the Revenue Act of 1916, c. 463, 39 Stat. 756, and

specifically under Section 5 (a) thereof, which

reads, so far as material, as follows (p. 759) :

Sec. 5. That in computing net income in

the case of a citizen or resident of the

United States—

(a) For the purpose of the tax there shall

be allowed as deductions—

* * * * *

Eighth. (a) In the case of oil and gas

wells a reasonable allowance for actual reduc-

tion in flow and production to be ascertained

not by the flush flow, but by the settled pro-

duction or 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 regula-

tions to be prescribed by the Secretary of the

Treasury: Provided, That when the allow-

(24)

25

ances authorized in (a) and (b) shall equal

the capital originally invested, or in case of

made prior to March first, nineteen

hundred and thirteen, the fair market value

as of that date, no further allowance shall

be made. No deduction shall be allowed for

any amount paid out for new builaings, per-

manent improvements, or betterments, made

to increase the value of any property or

estate, and no deduction shall be made for

any amount of expense of restoring property

or making good the exhaustion thereof for

which an allowance is or has been made.

Taxes for the year 1918 are controlled by the Rev-

enue Act of 1918 (c. 18, 40 Stat. 1057, 1066, 1067),

which provides in part as follows:

Sec. 214. (a) That in computing net in-

come there shall be allowed as deductions:

* * * * *%

(10) In the case of mines, oil and gas

wells, other natural deposits, and timber, a

reasonable allowance for depletion and for

depreciation of improvements, according to

the peculiar conditions in each case, based

upon cost. including cost of development not

otherwise deducted: Provided, That in the

case of such properties acquired prior to

March 1, 1913, the fair market value of the

property (or the taxpayer’s interest there-

in) on that date shall be taken in lieu of cost

up to that date: Provided further, That in

the case of mines, oil and gas wells, discov-

ered by the taxpayer, on or after March 1,

26

1913, and not acquired as the result of pur-

chase of a proven tract or lease, where the

fair market value of the property is mate-

rially disproportionate to the cost, the de-

pletion allowance shall be based upon the fair

market value of the property at the date of

the discovery, or within thirty days there-

after; such reasonable allowance in all the

above cases to be made under rules and regu-

lations to be prescribed by the Commis-

sioner with the approval of the Secretary.

In the case of leases the deductions allowed

by this paragraph shall be equitably appor-

tioned between the lessor and lessee.

Complying with the provisions of the statutes.

the following regulations were made:

Regulations 45 (1920 ed.) relating to the income

tax under the Revenue Act of 1918.

Art. 201. Depletion of mines, oil and gas

wells; depreciation of improvements.—Sec-

tions 214 (a) (10) and 234 (a) (9) provide

that taxpayers shall be allowed as a deduc-

tion in computing net income in the case of

natural deposits a reasonable allowance for

depletion of mineral and for depreciation of

improvements. The provisions of the stat-

ute and these articles do not apply to or

affect the regulations covering invested

capital, losses, accounting methods, etc.

The essence of these provisions of the stat-

ute is that the owner of mineral deposits,

whether freehold or leasehold, shall within

the limitations prescribed, secure through an

27

aggregate of annual depletion and deprecia-

tion deductions the return of either (a) his

capital invested in the property, or (b) the

value of his property on the basic date, plus

subsequent allowable capital additions (see

article 222), but not including land values

for purposes other than the extraction of

minerals.

Operating owners, lessors, and lessees,

whether corporations or individuals, are en-

titled to deduct an allowance for depletion

and depreciation * * *,

Art. 204. Capital recoverable through de-

pletion in case of lessor.—(a) In the case

of a lessor, the capital remaining in any year

recoverable through depletion and deprecia-

tion deductions is (1) the value of his equity

in the property at the basic date minus

(2) depletion and depreciation sustained,

whether legally allowable or not, from the

basic date to the taxable year, plus (3) sub-

sequent allowable capital additions, and

minus (4) the value of the land at the basic

date for other purposes than mineral pro-

duction. The capital recoverable through

depletion is the total capital remaining less

the sum recoverable through depreciation.

(b) The value of the equities of lessor and

lessee shall be computed separately, but,

when determined as of the same basic date,

shall together never exceed the value at that

date of the property in fee simple.

* * * *

(d) The value of a lessor’s equity in a

mineral property under lease March 1, 1913,

for the entire operating life of the mineral

deposits is the value as of March 1, 1913, of

the royalties and other payments to be ex-

pected under the terms of the lease in effect

on that date.

(e) The value of a lessor’s equity in a

mineral property under lease for a portion

of its operating life is the value as of March

1, 1913, of the royalties expected from the

mineral to be extracted during the life of the

existing lease plus the estimated en bloc value

of the mineral remaining at its expiration,

which, in the absence of satisfactory evi-

dence to the contrary, will be presumed not

to exceed the value as of March 1, 1913, of

royalties which could have been expected as

at that date from the remaining mineral.

Art. 206. Determination of fair market

value of mineral property.—-(a) Where the

fair market value of the property at a speci-

fied date in lieu of the cost thereof is the

basis for depletion and depreciation deduc-

tions, such value must be determined, sub-

ject to approval or revision by the Commis-

sioner, by the owner of the property in the

light of the conditions and circumstances

known at that date, regardless of later dis-

coveries or developments in the property or

subsequent improvements in methods of ex-

traction and treatment of the mineral prod-

uct. The value sought should be that es-

tablished assuming a transfer between a will-

ing seller and a willing buyer as of that par-

ticular date. The Commissioner will lend

due weight and consideration to any and all

factors and evidence having a bearing on the

29

market value, such as cost, actual sales and

transfers of similar properties, market value

of stock or shares, royalties and rentals,

value fixed by the owner for purpose of the

capital-stock tax, valuation for local or State

taxation, partnership accountings, records

of litigation in which the value of the prop-

erty was in question, the amount at which the

property may have been inventoried in pro-

bate court, disinterested appraisals by ap-

proved methods such as the present value

method and other factors.

(b) To determine the fair market value

of a mineral property by the present value

method, the essential factors must be deter-

mined for each deposit included in the prop-

erty. The factors are (1) the total quantity

of mineral in terms of the principal or cus-

tomary unit (or units) paid for in the prod-

uct marketed, (2) the average quality or

grade of the mineral reserves, (3) the ex-

pected percentage of extraction or recovery

in each process or operation necessary for

the preparation of the crude mineral for

market, (4) the probable operating life of

the deposit in years, (5) the unit operating

cost, i. e., cost of production exclusive of de-

preciation and depletion, (6) expected aver-

age selling price per unit during the operat-

ing life, and (7) the rate of profit com-

mensurate with the risk for the particular

deposit. When the deposit has been suffi-

ciently developed these factors may be de-

termined from past operating experience.

30

In the application of factors derived from

past experience full allowance should be

made for probable future variations in the

rate of exhaustion, quality or grade of the

mineral, percentage of recovery, costs of

production, and selling price of the product

marketed during the expected operating life

of the mineral deposit.

* * x * *

(c) Mineral deposits for which these fac-

tors may not be determined with reasonable

accuracy from past operating experience

may, with the approval of the Commissioner,

be valued in a similar manner; but the fac-

tors must be deduced from concurrent evi-

dence such as the general type of the deposit,

the characteristics of the district in which

it occurs, the habit of the mineral deposits

in the property itself, the intensity of min-

eralization, the rate at which additional min-

eral has been disclosed by exploitation, the

stage of the operating life of the property,

and other evidence tending to establish a

reasonable estimate of the required factors.

(d) Mineral deposits of different grades,

locations, and probable dates of extraction

in a mineral property shall be valued sep-

arately. The mineral content of a deposit

should be determined in accordance with

article 208 in the case of mines, with article

209 in the ease of oil wells, and with articles

211 and 212 in the case of gas wells. In esti-

mating the average grade of the developed

and prospective mineral, account should be

taken of probable increases or decreases as

31

indicated by the operating history. The rate

of exhaustion of a mineral deposit should be

determined with due regard to the limita-

tions imposed by plant capacity, by the char-

acter of the deposit, by the ability to market

the mineral product, by labor conditions, and

by the operating program in force or defin-

itely adopted at the basic date for future

operations. The operating life of a mineral

deposit is that number of years necessary for

the exhaustion of both the developed and

prospective mineral content at the rate de-

termined as above. The operating cost com-

prises all current expense of producing, pre-

paring, and marketing the mineral product

sold, exclusive of Federal income, war prof-

its, and excess profits taxes, allowable capi-

tal additions as defined in article 222, and de-

ductions for depreciation and depletion, but

including cost of repairs and replacements

necessary to maintain the plant and equip-

ment at its rated capacity and efficiency.

This cost of repairs and replacements is not

to be confused with the depreciation deduc-

tion by which the cost or value of plant and

equipment is returned to the taxpayer free

from tax. In general no estimates of these

factors will be approved by the Commis-

sioner which are not supported by the operat-

ing experience of the property or which are

derived from different and arbitrarily se-

lected periods.

(e) The product of the number of units of

mineral recoverable in marketable form by

the difference between the selling price

32

and the operating cost per unit is the total

expected operating profit. The value of

each mineral deposit is then the total ex-

pected operating profit from that deposit re-

duced to a present value as of the basic date

at the rate of interest commensurate with the

risk for the operating life, and further re-

duced by the value at the basic date of the

depreciable assets and of the eapital addi-

tions, if any, necessary to realize the profits.

Awe, 210. * © °

(b) When the value of the property at the

basie date has been determined, depletion for

the taxable year shall be determined by divid-

ing the value remaining for depletion by the

number of units of mineral to which this

value is applicable, and by multiplying the

unit value for depletion, so determined, by

the number of units sold within the taxable

year. In the selection of a unit for depletion

preference shall be given to the principal or

customary unit or units paid for in the prod-

uct sold.

Regulations 33 (Revised) governing the collec-

tion of the income tax imposed by the Act of Sep-

tember 8, 1916:

Arr. 172. If the property was acquired by

purchase or otherwise (other than by lease)

prior to Mareh 1, 1913, the amount of in-

vested capital which may be extinguished

through annual depletion deductions from

gross income will be the fair market value of

the mine property so acquired, as of March

1, 1913. The value contemplated herein as

the basis for depletion deductions authorized

33

by this title must not be based upon the as-

sumed salable value of the output under cur-

rent operative conditions, less cost of pro-

duction, for the reason that the value so de-

termined would comprehend the profits to be

realized from operation of the property.

Neither must the value determined as of

March 1, 1913, be speculative, but must be

determined upon the basis of the salable

value en bloc as of that date of the entire de-

posit of minerals contained in the property

- owned, exclusive of the improvements and

development work; that is, the price at

which the natural deposits or mineral prop-

erty as an entirety in its then condition

could have been disposed of for cash or its

equivalent.

I'he en bloc value having been thus ascer-

tained, an estimate of the number of units

(tons, pounds, ete.) should be made. The en

bloc value divided by the estimated number

of units in the property will determine the

per unit value, or amount of capital appli-

cable to each unit, which, multiplied by the

number of units mined and sold during any

one year, will determine the sum which will

constitute an allowable deduction from the

gross income of that year on account of

depletion.

Leductions computed on a like basis may

be made from year to year during the own-

ership under which the value was deter-

mined, until the aggregate en bloc value as

of March 1, 1913, of the mine or mineral de-

posits shall have been extinguished, after

34

which no further deduction on acount of de-

pletion with respect to this property will be

allowed to the individual or corporation

under whose ownership the en bloc value was

determined.

APPENDIX B

SUPPLEMENTARY DISCUSSION OF OPINION OF THE

CIRCUIT COURT OF APPEALS

(a) The Cireuit Court of Appeals held that the

depletion rate determined by the Commissioner

was not a correct rate because it did not represent

the value in place of a ton of ore on March 1, 1913.

In so holding, the court, relying entirely upon the

Revenue Act of 1916, said (R. 162) :

Section 5 (Eighth-b) of the revenue act of

1916 (39 U. 8. Stats. at L., p. 756, 759) pro-

vides that there shall be an allowance for

depletion ‘‘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.’’ This language, by its terms, has

nothing to do with the whole body of the ore

in place. It is not related to the market

value of all of the tonnage in the mine, but

the depletion relates to the market value in

the mine of the product mined and sold dur-

ing the year for which the return is made.

We submit that the Circuit Court of Appeals has

misconstrued the section of the 1916 Act relied

upon. The court seems to consider that the mar-

35

ket value im the mine of the product sold is the nec-

essary measure of such allowance. We contend

that the statutory provisions quoted in the above

extract from the opinion are intended merely to

prevent the deduction of a depletion allowance in

excess of the income produced by the mine during

the year with respect to which the depletion is

claimed. This might occur in the case of one who

operates a mine at a loss in a given year. It is not

intended as the measure of depletion, for this Court

has indicated in the Ludey case, supra, that the

proper allowance under this Act is a pro rata part

of the capital investment. That the language

quoted is a limitation and not the measure of de-

pletion is further evident from the construction

given in Lynch v. Alworth-Stephens Co., 267 U. 8.

364, 369, supra, to the provision relating to corpo-

rate deductions:

The general provision in section 12 (a),

Second, is that the deduction from gross in-

come shall include a reasonable allowance

for the ‘‘exhaustion * * * of prop-

erty.’’ There is nothing to suggest that the

word “property”’ is used in any restricted

sense. In the case of mines, a specific kind of

property, the exhaustion is described as de-

pletion, and is limited to an amount not

exceeding the market value in the mine of

the product mined and sold during the year.

The conclusion of the Circuit Court of Appeals

upon this point was reached without reference to

the provisions of the Revenue Act of 1918, which

governs one year involved in this case.

(b) The Cireuit Court of Appeals assumed that

the depletion allowance and March 1, 1913, value

were determined by the Commissioner without

reference to the interest which the quarterly pay-

ments would produce after their respective receipts.

There is nothing in the record to justify such an

assumption. Indeed it appears to be contrary to

the facts, for the present value of $1 to be received

at the end of 40 years, discounted at 6%, is 0.097222.

Principles of Valuation, Grimes & Craigue, page

224.

Henee, it is perfectly apparent that the Com-

missioner did not, as the court’s opinion states, pro-

ceed upon ‘‘the assumption that the value of the

leases to plaintiff at the end of 40 years, will be

$7,849,287.18.’’ (R.160.) This figure (which was

not in his final computation) was the aggregate

amount of the payments which she might expect

under the leases—i. e. for 31,397,148.7 tons at 25

cents per ton, as appears from the figures in the

tabulation immediately above this statement in the

opinion.

(c) The ‘‘average extraction, 1913 to 1918,’’ in-

elusive, is criticized by the court (R. 161) because,

at the time this case was tried, it appeared that the

extraction for 1917 and 1918 was vastly in excess of

the earlier years. On March 1, 1913, the date as of

which the value, and consequently the rate of ex-

traction, must be determined, it would not have

been possible to foresee and therefore to modify the

lessees’ extraction programs in the light of the de-

mand created by the World War. The extraction

program as well as the reserve is at best an estimate.

37

(d) The fact adverted to by the court (R. 161)

that some leases had a shorter life than 40 years

does not by any means show that the entire re-

sources would be exhausted before that time. It

could, for valuation purposes at least, make no pos-

sible difference to the lessor whether the royalties

were paid in respect to one mine or another. The

short-term leases were held by those who also held

the long term, and it may well have been that the

-whole was to be extracted in 40 years at an average

rate.

(e) The court says (R. 162):

It can not be possible that the 1913 value can

be fixed by the lease at .0886243 and at the

same time have the lease yield to plaintiff 25

cents per ton for 1913 and every succeeding

year of operation.

One who invests his capital to be repaid him in

installments, over a long period, contemplates re-

ceiving each year income on his remaining invest-

ment, not merely on that part of his investment

which he recovers in the year.

According to Hoskold’s Table, the present value

of $1 in accumulated earnings of equal annual in-

stallments over a period of 40 years on the basis of

interest at 6% on the investment with a return of

capital at 4%, is 0.354491. Saliers, Depreciation,

Principles and Applications, pp. 467-468. On this

basis 25 cents would have a present value of

0.08862+.

(f) The statement of the ‘‘Government’s figures

and processes’’ set forth in the opinion (R. 160) is

taken from the taxpayer’s Exhibit K. (R. 128.)

But it is clear from the record that there were

38

later computations which gave different results

-and that Exhibit K does not show the manner in

which the allowance was finally computed. The

depletion allowance for 1917 is shown on Exhibit

K as $92,194.92, but the certificate of overassess-

ment for 1917 (Plaintiff’s Exhibit M, R. 138

139) and the claim for refund for 1917 (Plain-

tiff’s Exhibit R, R. 144-145) show that the final al-

lowance for depletion was in fact $99,561.20. Like-

wise the allowance for 1918 was increased by the

Commissioner, and instead of $77,968.20 (Plain-

tiff’s Exhibit O, R. 141), $84,979.55 was finally al-

lowed (Plaintiff’s Exhibit P, R. 143).

APPENDIX C

EXTRACT FROM THE RECORD IN McHALE v. HULL

The following is an excerpt from the Agreed

Statement of Facts (R. 48-49) in McHale v. Hull,

No. 3780, in the Circuit Court of Appeals for the

Seventh Circuit. This is the case referred to by

the District Court (R. 44) and by the Cireuit Court

of Appeals (R. 159) in the instant ease.

The computation of the March 1, 1913,

value of the plaintiff’s royalty equity in each

mine under each indenture was made by said

Commissioner as follows:

(1) The rate of royalty per ton was multi-

plied by the total estimated tonnage of ore

to determine gross expected royalty income.

(2) From gross expected royalty income a

deduction of three per cent was made to de-

termine net expected royalty income; ag the

said Commissioner has determined that the

39

average cost incurred by all lessors of iron

mines in Minnesota for legal, engineering,

aceounting and other services, and for office

expenses in connection with royalty collec-

tion amounts to approximately three per

centum of the total royalties received.

(3) The March 1, 1913, value of ‘the net

expected royalty income was determined by

multiplying the net expected royalty income

by a discount factor. This discount factor

was selected in accordance with the sinking

fund method for valuing equal annual

amounts of income. By this method the net

expected royalty income (which said Com-

missioner assumed would be in equal annual

amounts from March 1, 1913, to the end of

the unexpired term under each indenture),

pays simple interest of six per centum annu-

ally upon the March 1, 1913, value, so deter-

mined, and provides annually, in addition, a

residuum of equal annua! amounts which, if

invested to accumulate at four per cent inter-

est, compounded annually, would provide for

the return of the March 1, 1913, value of the

net expected royalty income under each in-

denture, at the expiration of the term of each

indenture. The depletion rete per ton of ore

for which royalty payment was received by

the plaintiff in 1917 was computed by said

Commissioner, by dividing the March 1, 1913,

value of the net expected royalty income by

the total estimated ionnage of ore in the mine

subject to each indenture. The depletion de-

duction from gross income of $99,561.20, was

ety

40

computed by said Commissioner as the sum

of the amounts under each indenture deter-

mined by multiplying the several depletion

rates per ton by the tonnages of ore for

which royalty payment was received by the

plaintiff during 1917, under the several in-

dentures,

©. G, COVERERERT PRINTING OFFICE: 1929