Petitioners Brief — Burnet v. Harmel

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No. 26 :

Guthe Pupreme Gourtoft ine Waited ints

Ocroser eno 1932

Davw Burnet, ComMMISsiONER OF INTERNAL

REVENUE, PETITIONER -

Vv.

Henry HaRMEL

ON WRIT OF CERTIORARI TO THE UNITED STATES CIROUIT :

COURT OF APPEALS FUs THE FIFTH BISlRieT SUEY

BRIEF FOR THE PETITIONER.

RI NO Wi oso eee ce cane eene he glen agauusemicanas

a a di os aisviones oiiadh'is oat @ diniie sind win thaetn pile ered wim ip @ Mace te

ire i cashlierbhnunapsctnnasmoceshanens

ON dis ian Sheva en swnaehs bonnes Sameecinw

REESCG Si seh owe na ckcccl ot weep aeidmelnakeasseneewcne

Specification of errors to be urged__-..._-...----------------

Summary of argument. -____......-----------------------.

Argument:

I. The payments received by respondent were advance

INC is didi cial Ast ia Mike ie a mss tthe ip rg Baa

II. Since a bonus is advance rental or royalty, the p»y-

ments received by respondent should be classified

as royalties and returned as ordinary income_.-___

III. The statute does not make its application dependent

upon state rules as to the effect of oil leases between

the parties thereto, and therefore such state rules

must be disregarded in applying the statute_._____

SIREN LUN, Con Cbibeld ie wie be okbun illic mei nokia oe

CITATIONS

Cases:

Aldridge v. United States, 64 C. Cls. 424.___.__-_.-____-

Alexander v. King, 46 F. (2d) 235, certiorari denied, 283

Alland & Bro., J., v. United States, 28 F. (2d) 792_..____-

American Tobasce Co. v. Werckmeister, 207 U. S. 284__.__-

Baltimore Talking Board Co. v. Miles, 280 Fed. 658, certi-

orari denied, 259 U. S. 587___..........-.-.--..---_-

Bankers Pocahontas Coal Co. v. Commissioner, 55 F. (2d)

626, No. 104, Oct. Term, 19382_____...__._-.__-__- 20,

Baton Coal Co. v. Commissioner, 19 B.T. A. 169, affirmed,

51 F. (2d) 469, certiorari denied, 284 U. 8S. 674.________

Berg v. Commissioner, 33 F. (2d) 641, certiorari denied, 280

Black & White Taxicab Co. v. Brown & Yellow Tazicab

CEO. OOo abs UR e ek Albee is Uke naccucmcs

Boston & Maine R. R. v. United States, 265 Fed. 578, certi-

orari denied, 255 U. S. 577_.........----------.------

P

age

it

1

2

2

4

4

5

, 22, 26

eo PRIS RED SRS

——

I

Cases—Continued. Page

Bowers v. Lawyers Mortgage Co., 285 U. 8. 182......--.-- 17,19

Burk-Waggoner Oil Assn. v. Hopkins, 269 U. 8. 110_... 23, 29, 30

Burkett v. Commissioner, 7 B. T. A. 560, affirmed, 31 F. (2d)

667, certiorari denied, 280 U. 8. 565.-.....--.-- 10, 11, 12, 16

Burnet v. Coronado Oil & Gas Co., 285 U. 8. 393__....---- 27

Calhoun Gold M. Co. v. Ajax Gold M. Co., 182 U. 8. 499__- 23

California Iron Yards Co. v. Commissioner, 48 F. (2d) 514- 24

Central Nat. Bank of Tulsa, Okla., v. United States, 283 Fed.

368, dismissed, 264 U. 8. 600_...........------------ 12

Constantine v. Wake, 1 Sweeny (N. Y.) 239_.....-------- 12

Crescent Live Stock Co. vy. Butchers’ Union, 120 U. 8. 141-- 23

Crile vy. Commissioner, 55 F. (2d) 804.......-.---------- 12

Crooks v. Harrelson, 282 U. 8. 55.......-.-------------- 24

Eagan v. Commissioner, 43 F. (2d) 881_.....------------ 23

Ewert v. Robinson, 289 Fed. 740_.......---------------- 14, 32

Ferguson v. Commissioner, 20 B. T. A. 130, reversed, 45 F.

Ca baa aswigncGuk, Sdddescadeivhenesre 7, 11, 20, 31

Ferguson, W. M., v. Commissioner (C. C. A. 10th), decided

NNN Eh et ait dalcmat alah up Ue wane mewn e 10

Fidelity-Philadelphia Trust Co. v. Commissioner, 47 F. (2d)

Ge Oe ee a os ub uanine hawdnaeae 23

First Nat. Bank in Dallas v. Commissioner, 45 F. (2d) 509,

certiorari denied, 283 U. 8. 845........-------------- 23

Frost-J ohnson Lumber Co. v. Salling’s Heirs, 150 La. 756- - - - 14

Galatoire Bros. v. Lines, 23 F. (2d) 676....-.-...-------- 12

Goldfield Consol. Mines Co. v. Scott, 247 U. 8. 126_...------ 12

Group No. 1 Oil Corp. v. Bass, 283 U. 8. 279......------- 26, 27

Guffey v. Smith, 237 U. 8. 101............-------------- 23

Hart v. Commissioner, 54 F. (2d) 848.....:.--.--------- 24

Hazlett v. Commissioner, 10 B. T. A. 382_.--.----.------ 11

Hirschi vy. United States, 67 C. Cls. 637, certiorari denied,

Ede bab Ad Cosh eciknewovensusoooscan 10, 12, 20, 22

Humphreys-Mezia Oil Co. v. Gammon, 113 Tex. 255---.- --- 8

Jamison Coal & Coke Co. v. Commissioner, 24 B. T. A. 554-- 20

Jennings & Co. v. Commissioner, 59 F. (2d) 32__.-.----- 12

Jones v. Murphy, 253 8. W. 634_.......---------------- 15

Kelley v. The Ohio Oil Co., 57 Ohio 317.......---------- 14

Louisville Gas Co. v. Kentucky Heating Co., 132 Ky. 435. --.-. 14

Lynch v. Alworth-Stephens Co., 267 U. 8. 364_....-------- 14

Merchants’ Loan & Trust Co. v. Smietanka, 255 U. 8. 509. 13

Murphy Oil Co. v. Commissioner, No. 80, October Term ,1932 7

Nelson Land & Oil Co., Appeal of, 3 B. T. A. 315....-.-.-- 10, 11

Ohio Oil Co. v. Indiana (No. 1), 177 U. 8. 190...-------- 14

~~

m1

Cases—Continued. Page

Old Colony R. Co. v. Commissioner, 284 U. 8. 552.......-.. 15

Osburn California Corp. v. Welch, 39 F. (2d) 41, certiorari

SRR HE is > Sn Chek acpsecsweseswcssepecoasap> 23

Parkey v. Commissioner, 16 B. T. A. 441_.-......-..---- 11

Pe, hs POE De Bbc cdcckenkpooassanaquseneae 24, 25

Rich v. Doneghey, 71 Okla. 204.__......-.-.------------ 14

Rosenberger v. McCaughn, 25 F. (2d) 699, certiorari denied,

ek er EN cis ative cha he neon Ade babe 20, 21, 24

St. Louis Union Trust Co. v. Burnet (C. C. A. 8th), decided

PE AO CE Sonal ancewtivdenwisdacdanh nn aqpeeh amines 24

Southern Pacific Co. v. Lowe, 247 U. 8. 330_.--....------ 13.

Bilty 9. VERE, 00 Bs, We Wi ecnctngupntucrdanctoncees 24

Stanton v. Baltic Mining Co., 240 U. 8. 1038_._...-.----~- 12, 13

State v. The Ohio Oil Co., 150 Ind. 21. .......-.:--....-- 14

Stephens County v. Oil & Gas Co., 113 Tex. 160..--..._.- 8, 15

Stratton’s Independence v. Howbert, 231 U. 8. 399___-___-- 12, 13

Texas Co. v. Daugherty, 107 Tex. 226.............---- 8, 15, 26

Tyler'v. United States, 261 U. 8, 407..................-. 24

United States v. Cambridge Loan & Bldg. Co., 278 U.S. 55_ 24, 25

United States v. Biwabik Mining Co., 247 U. 8. 116__.. 10, 13,14

United States v. Childs, 266 U. 8. 304 eae alike keds esas sass ih 23.

United States v. Malcolm, 282 U.S. 792..-.----...------ 25

United States v. Merriam, 263 U. 8. 179._......---....-.-- 15

United States v. Robbins, 269 U.S. 315..--..----...--.-- 25

Von Baumbach v. Sargent Land Co., 242 U.8. 503. 13, 14, 20, 22, 27-

Waggoner v. Commissioner, 24 B. T. A. 657__--...------- 11

Waggoner Estate v. Sigler Oil Co., 118 Tex. 509.....--.--- 8

Wagner ¥. Mallory, 100 his {GOL sin cc cdcn cc cccncccse 14

Paste ee NG OEE Os Oy Beene odtdvacdcuisnacaunesnnn 23, 29

Wes ©. POTRROT, BT Be TRG) Cli ncccnccccusckundscucse 24

Watford Oil & Gas Co. v. Shipman, 233 Ill. 9_...-..--._-- 14

AE SR AON A) Dd teens einuw@baduncdddeiad 9, 10

PG Vi. SURED, BOO Gs Es DORE bed rccmndsdanseacnececde 15

Statutes:

Revenue Act of 1924, c. 234, 43 Stat. 262, Sec. 208 (U.S. C.,

EE vine ctnrvclibwauiGligeacndndamaceas 2-4

Miscellaneous:

Bi Meniey O) SAAR TD, Dy DO Ra dk daiednadendskabocuccen 11

Conference Report No. 844, 68th Congress. 1st Sess., p. 15_- 17

H. R. 179, 68th Congress, 1st Sess., pp. 19-20_...._..___. 17

H. R. 350, 67th Congress, 1st Sess., pp. 10-11_.......___. 17

Bee AUR EAs Ws Es Mth ad ntdanndndshdbenboadcvchows 11

Klein, Federal Income Taxation, p. 439_..............-- 12

SD RE, BG OU SOT ovo bin cw asdbestictcunacaveuns 15

8. R. No. 398, 68th Congress, Ist Sess., pp. 21-22__......_. 17

1 Tex. Law Review 163, 170-178

a

Iv

Miscellaneous—Continued. Page

Thornton, Oil and Gas (4th Edition) —

PE Naansicad no chetaseavok. sacha ehaswends 15

DSS halen isintindian ses tebawe Saleecedsee 15

ee Pe NN EIN Gk wccndcancbpnnunenncenecbines 7

Regulations: .

Treasury Regulations 45, Art. 109_._................---. ll

Treasury Regulations 55, Art. 20.................----... 31-32

Treasury Regulations 62, Art. 109__......_........-..-. ll

Treasury Regulations 65—

PP EEE Garis Heb dnedachanbhdencrecastcusune ll

Article 216, as amended by T. D. 3938, V—2, C. B. 117_- 7

Treasury Regulations 69, Art. 110_..................... 11

Treasury Regulations 74, Art. 130__..................-. ll

Inthe Supreme Court of the United States

OctoBeR TERM, 1932

No. 26

Davin BurNET, COMMISSIONER OF INTERNAL

Revenue, petitioner

Vv.

HENRY HARMEL

ON WRIT OF CERTIORARI TO THE UNITED STATES CIRCUIT

COURT OF APPEALS FOR THE FIFTH CIRCUIT

BRIEF FOR THE PETITIONER

OPINIONS BELOW

The opinion of the Circuit Court of Appeals

for the Fifth Circuit (R. 20) is reported in 56 F.

(2d) 153. The opinion of the Board of Tax

Appeals (R. 8-10) is reported in 19 B. T. A. 376.

JURISDICTION

The judgment of the Circuit Court of Appeals

for the Fifth Circuit was entered February 23,

1932. (R. 21.) Petition for a writ of certiorari

was granted April 18, 1932. Jurisdiction is con-

(1)

2

ferred upon this Court by Section 240 (a) of the

Judicial Code as amended by the Act of February

13, 1925.

QUESTION PRESENTED

Whether cash bonuses paid as advance royalties

under oil and gas leases on lands in the State of

Texas constitute income from the sale of capital

assets within the meaning of Section 208 of the

Revenue Act of 1924.

STATUTE INVOLVED

Revenue Act of 1924, c. 234, 43 Stat. 253, 262:

Sec. 208 (a) For the purposes of this

title—

(1) The term ‘‘eapital gain’? means tax-

able gain from the sale or exchange of cap-

ital assets consummated after Decemter 31,

1921;

(2) The term ‘‘capital loss’? means de-

ductible loss resulting from the sale or

exchange of capital assets ;

(3) The term ‘‘capital deductions’’ means

such deductions as are allowed by section

214 for the purpose of computing net in-

come, and are properly allocable to or

chargeable against capital assets sold or

exchanged during the taxable year;

(4) The term ‘ordinary deductions”’

means the deductions allowed by section 214

other than capital losses and capital deduc-

tions ;

(5) The term ‘‘capital net gain’’ means

the excess of the total amount of capital

—eeeEE7™O~™

3

gain over the sum of (A) the capital deduc-

tions and capital losses, plus (B) the amount,

if any, by which the ordinary deductions

exceed the gross income computed without

including capital gain;

(6) The term ‘‘capital net loss’’ means

the excess of the sum of the capital losses

plus the capital deductions over the total

amount of capital gain ;

(7) The term ‘ordinary net income’”’

means the net income, computed in accord-

ance with the provisions of this title, after

excluding all items of capital gain, eapital

loss, and capital deductions ; and

(8) The term ‘capital assets’’ means prop-

erty held by the taxpayer for more than two

years (whether or not connected with his

trade or business), but does not include stock

in trade of the taxpayer or other property of

a kind which would properly be included

in the inventory of the taxpayer if on hand

at the close of the taxable year, or property

held by the taxpayer primarily for sale in

the course of his trade or business.

(b) In the case of any taxpayer (other

than a corporation) who for any taxable

year derives a capital net gain, there shall

(at the election of the taxpayer) be levied,

collected and paid, in lieu of the taxes im-

posed by sections 210 and 211 of this title, a

tax determined as follows:

A partial tax shall first be computed upon

the basis of the ordinary net income at the

rates and in the manner provided in sections

_

—

4

210 and 211, and the total tax shall be this

amount plus 12% per centum of the capital

net gain.

* * * * *

(U. 8. C., Title 26, See. 939.)

STATEMENT

The respondent is an individual residing at Me-

gargel, Texas. In the year 1924 he was, and had

been for many years, the owner in fee simple of cer-

tain lands (R. 8) in the State of Texas (R.2). In

October, 1924, he executed two oil and gas leases of

such lands for terms of three years and as long as

oil or gas should be produced from the land by the

lessees on the basis of stipulated royalties measured

by the lessees’ production of oil and gas and a cash

consideration of $57,000. (R.8, 15,17.) This cash

payment was returned by respondent as gain from

sales of capital assets, under Section 208 of the

Revenue Act of 1924. (R.9.) The Commissioner

of Internal Revenue treated it as income, taxable

at the ordinary rates. (R. 5, 9.) The Board of

Tax Appeals held with the Commissioner (R. 10),

but the Circuit Court of Appeals for the Fifth

Circuit reversed the Board (R. 20-21.)

The two oil leases referred to above are set out

in full in the record. (R. 14-19.)

SPECIFICATION OF ERRORS TO BE URGED

The court below erred:

1. In holding that cash bonuses paid as advance

royalties for the execution of oil and gas leases in

5

the State of Texas constitute income from the sale

of capital assets, within the meaning of Section 208

of the Revenue Act of 1924.

2. In holding that in determining the question

presented it was bound by the decisions of the

Texas courts that leases of oil lands constitute

sales of the oil.

3. In reversing the decision of the Board of Tax

Appeals.

. SUMMARY OF ARGUMENT

A cash bonus paid upon the execution of an oil

and gas lease is to be treated as advance royalty.

The distinction made by the court below between

bonus and royalty is unsound and is contrary to

the decided cases.

The capital-gains provisions of the statute first

appeared in the Revenue Act of 1921. At that time

it was settled by the decisions of this Court that roy-

alties are ordinary income and are not to be treated

under the Revenue Acts as proceeds from the con-

version of capital assets. The statute here involved

contains no definition of the term ‘‘sale of capital

assets” which is decisive. But it is to be presumed

that Cougress intended to deal only with those

transactions which under general law, as it then

existed, constituted sales of capital assets. A con-

sideration of the purpose of the legislation supports

this conclusion. The classification made in the

statute was designed to stimulate ‘‘sales’’ of prop-

erty which was then being held off the market

140784—32——-2

because of the burden of taxes theretofore im-

posed upon ‘capital gains’’ accumulated over a

number of years and realized upon the ‘“‘sale”’ of

property which had enhanced in value. Rentals

and royalties from oil leases were not within the

purpose of the law in reducing taxes upon ‘“‘capital

gains.”’

The court below erroneously held that decision

was controlled by the local rule that such leases as

are here involved constitute sales of oil and gas in

- place. This Court has indicated that local rules

may be disregarded in classifying the income from

mineral leases, and until the decision below that was

thought to be the correct view. It is true that

where a Federal statute is so drawn that it either

expressly or by necessary implication requires re-

sort to the local law the Federal courts will be

guided by the local rule. But that is not the situa-

tion here, and the cases relied upon below are there-

fore distinguishable.

ARGUMENT

I

THE PAYMENTS RECEIVED BY RESPONDENT WERE

ADVANCE ROYALTIES

The court below held that the cash bonuses

received by respondent under oil and ‘gas leases *

* These leases were made “ for the sole and only purpose

of mining and operating for oil and gas and of laying pipe

lines and of building tanks, power stations, and structures

thereon to produce, save, and take care of said products

* °° 9”. (RB 14-18, 17.)

—S_—"——

7

were gains from the sale of capital assets and not

ordinary income. This conclusion was based upon

its earlier decision in Ferguson v. Commissioner,

45 F. (2d) 573. In that case a distinction was

drawn between a bonus and a royalty, and it was.

held that the former represented the proceeds

from the sale of oil and gas leases, while the latter

constituted proceeds from the retained interest of

the lessor which came to him from time to time as

revenue under the contract.

We are unable to apprehend any sound basis for

this distinction. The consideration for the lease

is the cash bonus and the future royalties. Appar-

ently the court below was impelled to make the dis-

tinction because of a misconception which it enter-

tained as to the scope of the depletion allowance.

It assumed that a depletion allowance was not made

to the lessor with respect to the bonus, while such

an allowance was made with respect to the royalty,

so that (p. 577) ‘‘this part of his capital is pro-

tected and returned.’’ The assumption that no

depletion allowance was permitted with respect to

the bonus is clearly erroneous. See Article 216,

Treasury Regulations 65, as amended by T. D.

3938, V-2 C. B. 117; Murphy Oil Co. v. Commis-

sioner, now pending in this Court, No. 80, October

Term, 1932.

——ay

8

Nor is the distinction made below between a bonus

and a royalty supported by the cases cited.? In

every case which has been found where the ques-

tion was presented it has been held that a bonus

does not differ from a royalty, but, on the con-

trary, constitutes a part of the royalty which is

paid in advance. The leading case on this point is

Work v. Mosier, 261 U. 8. 352, where this Court

held that a bonus paid for an oil and gas lease on

Indian land was (pp. 357-358) “part of the royalty

or rental ina lump sum * * *,”

The court below distinguished that case by treat-

ing it as announcing a rule applicable only to its

peculiar facts. But this Court’s discussion of the

nature of a bonus does not indicate that it was lim-

ited to the particular bonus there involved and that

other bonuses should be regarded differently. This

Court there said (pp. 357-358) :

The bonus which was the result of bidding

for desirable and profitable oil and gas

leases secured for the members of the Osage

Tribe the just value of the use of their prop-

erty which the fixing of royalties in advance

by the President was not adapted to give

them. It was in effect a supplement to the

royalties already determined. It was really

part of the royalty or rental in a lump sum

or down payment. We do not see how it can

* Texas Co. v. Daugherty, 107 Tex. 226; Stephens County

v. Oil & Gas Co., 118 Tex. 160; Humphreys-Mewia Oil Co. v.

Gammon, 113 Tex. 247, 255; Waggoner Estate v. Sigler Oil

@o., 118 Tex. 509.

ates oa —

be classified as anything else. It was in-

come from the use of the mineral resources

of the land. Of course, it involved a con-

sumption and reduction of the mineral value

of the land, but so does a royalty. This is

an inevitable characteristic of income from

the product of the mine. What was in-

tended to be distributed to the members of

the tribe was the income from the mineral

deposits in their lands, and the bonus was

part of that. Doubtless Congress had in

mind regular annual or quarterly equal pay-

ments when it used the word royalties;

and did not anticipate such large down pay-

ments. But in the unexpected event, we

must decide under what head the bonus is

| to be treated, whether as capital or income,

| and it seems clear to us that, in view of the

entire statute, it is more aptly described by

the latter term.

We submit that this Court did not reach the con-

clusion that bonuses were advance royalties because

of any peculiar provision of the statute involved,

but because they constituted ‘‘income from the use

of the mineral resources of the land’ (p. 358).

The question was squarely presented whether a

bonus should be classified as capital derived from

a disposition of property or as income paid for the

use thereof. Under Section 4, Second, of the

Osage Allotment Act (34 Stat. 544), it was the

“‘royalty’’ received from the leases which was to

be distributed to the individual members of the

tribe. This Court held (pr. 358) that ‘‘What was

a

10

intended to be distributed to the members of the

tribe was the income from the mineral deposits in

their lands, and the bonus was part of that.’ The

statute did not make the classification, and this

Court, in accordance with general principles of law,

held that such bonus was not capital, but income.

The controlling authority of Work v. M osier,

supra, has been uniformly recognized wherever the

distinction between bonus and royalty was sought

to be made. Alexander vy. King, 46 F. (2d) 235

(C. ©. A. 10th), certiorari denied, 283 U. S. 845;

W. M. Ferguson v. Commissioner (C. C. A. 10th),

decided June 30, 1932, reported in 323 C. 0. H.9062 :

Appecl of Nelson Land & Oil Co.,3 B. T. A. 315,

326. The court below stands alone in making a dis-

tinction between bonus and royalty. It is not made

in the following cases, which do not cite Work v.

Mosier: Burkett v. Commissioner, 7 B. T. A. 560,

affirmed, 31 F, (2d) 667 (C. ©. A. 8th), certiorari

denied, 280 U. 8. 565; Berg v. Commissioner, 33 F.

(2d) 641 (App. D. C.), certiorari denied, 280 U. 8.

598; Hirschi v. United States, 67 C. Cls. 637, cer-

tiorari denied, 280 U. S. 576. The latter case also

dealt with an oil lease of Texas lands, anc! its de-

cision is squarely opposed to the instant decision.

Support for the view that a bonus is to be treated

as an advance royalty is also to be found in the

decision of this Court in United Stutes y. Biwabik

Mining Co., 247 U.S. 116. The distinction between

bonus and royalty was not there in issue, but the

aE

11

Court tacitly assumed that they were not different

and treated them alike, quoting from the opinion

of the District Court as follows (p. 121):

The defendant paid $612,000 for the lease

under consideration and in addition assumed

the payment of the royalties stipulated for

therein. This may properly and justly be

considered a payment in advance of an in-

creased royalty on ore to be mined, and that

is precisely the character which the defend-

ant gave to the payment when aati with

it in its private accounts * *

Our contention that a bonus is advance royalty

is also supported by decisions in cases where lessee

taxpayers have sought to deduct the entire bonus

(under leases other than oil leases) as a business

expense in the year in which paid. It has uniform-

ly been held in such cases by the Bureau of In-

ternal Revenue,’ by the Board of Tax Appeals,* and

*Article 109, Treasury Regulations 45 and 62; Article 110,

Treasury Regulations 65 and 69; Article 130, Treasury

Regulations 74; I. T. 1711, II-2 C. B. 104; A. R. R. 6459,

III-1 C. B. 138.

* Nelson Land & Oil Co., 3 B. T. A. 315, 325-826; Bur-

kett v. Commissioner, 7 B. T. A. 560, affirmed, 31 F. (2d)

667 (C. C. A. 8th), certiorari denied, 280 U. S. 565;

Hazlett v. Commissioner, 10 B. T. A. 382, 387; Parkey v.

Commissioner, 16 B. T. A. 441, 445; Baton Coal Co. v. Com-

missioner, 19 B. T. A. 169, affirmed, 51 F. (2d) 469, (C. C.

A. 3d), certiorari denied, 284 U. S. 674; Ferguson v. Com-

missioner, 20 B. T. A. 130, 131, reversed, 45 F. (2d) 573

(C.C. A. 5th). Cf. Waggoner v. Commissioner, 24 B. T. A.

657.

a

a

12

by the courts * that such a bonus is advance rental

or royalty and that the deduction must be taken

over the life of the lease.

II

SINCE A BONUS IS ADVANCE RENTAL OR ROYALTY, THE

PAYMENTS RECEIVED BY RESPONDENT SHOULD BE CLAS.

SIFIED AS ROYALTIES AND RETURNED AS ORDINARY

INCOME

This Court has repeatedly held that royalties

from oil and gas leases are not to be treated under

the Revenue Acts as proceeds from the conversion

of capital assets, In 1913 this Court held in Strat-

ton’s Independence v. Howbert, 231 U. 8. 399, that

the profit realized from mines by operating owners

was income within the meaning of the excise tax

laid upon corporations and measured by their in-

come. Section 38, Act of August 5, 1909, e. 6, 36

Stat. 11, 112. This conclusion was reaffirmed in

1918 in Goldfield Consol. Mines Co. vy. Scott, 247

U.S. 126, In 1216 the same conclusion was reached

in Stanton v. Baltic Mining Co., 240 U. 8. 103, 114,

*Central Nat. Bank of Tulsa, Okla., v. United States,

283 Fed. 368, 373 (C. C. A. 8th), dismissed, 264 U. S. 600;

J. Alland & Bro. Inc. vy. United States, 28 F. (2d) 792

(Mass.) ; Hirschi v. United States, 67 C. Cls, 637; Burkett v.

Commissioner, supra; Baton Coal Co. v. Commissioner,

supra; Galatoire Bros. v. Lines, 23 F. (2d) 676 (C. C. A,

5th). See Constantine v. Wake, 1 Sweeny 239, 244 (N. Y.);

Klein, Federal Income Taxation, p. 439; Crile y. Commis.

sioner, 55 F. (2d) 804 (C. C. A. 6th). Cf. Jennings & Co.

Ine. v. Commissioner, 59 F. (2d) 32 (C. C. A. 9th). -

13

under the income-tax section of the Tariff Act of

October 3, 1913, c. 16, 38 Stat. 114, 166, 181.

While Stratton’s Independence v. Howbert and

Stanton v. Baltic Mining Co. related to the income

of operating owners, the same rule was applied to

lessors in 1917 in Von Baumbach v. Sargent Land

Co., 242 U. 8. 503, where it was held that royalties

received by lessors of iron-ore land constituted in-

come under the 1909 Act and not payments for the

sale of ore. The principle of the Sargent Land Co.

case was applied to a lessee in 1918, and the receipts

from a similar lease were held to be taxable income.

In United States v. Biwabik Mining Co., supra,

with respect to the rights of the lessee under the

lease, it was said (pp. 125-126) :

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.

While Stratton’s Independence v. Howbert arose

under the 1909 Act, ‘‘income”’ has the same meaning

in the Revenue Acts passed since the adoption of

the Sixteenth Amendment. Merchants’ Loan &

Trust Co. v. Smietanka, 255 U. 8. 509, 519; South-

ern Pacific Co. v. Lowe, 247 U. 8. 330, 335.

140784—82——_3

——ay

14

When the capital gains provisions first appeared

in the Revenue Act of 1921 (c. 136, 42 Stat. 227), it

was then regarded as settled law that mining leases

did not convey title to the ore in place. See Lynch

v. Alworth-Stephens Co., 267 U. 8. 364, 371,° and

Ewert vy. Robinson, 289 Fed. 740, 747" (C.C. A. 8th),

It was also then settled in several of the oil-pro-

ducing States that, although the proprietor of the

surface could bore wells for the purpose of extract-

ing gas and oil, he had no title whatever to them

as owner until the gas and oil were actually re-

duced to possession.’ At the same time it was

*In this case the Court said (p. 871): “It was held in

both cases [Von Baumbach v. Sargent Land Co. and United

States v. Biwabik Mining Co., supra}, as we hold here, that

the leases under consideration did not convey title to the ore

in place.”

* The court here said (p. 747) : “We are not dealing here

with the question of whether such leases are a grant of the

oil and gas or mineral within the ground. It is settled by

the decisions of the Supreme Court before referred to that

they gre not.”

"Ohio Oil Co. v. Indiana (No. 1) (1900), 177 U. S. 190;

The State v. The Ohio Oil Co. (1898), 150 Ind. 21, 32;

Lowisville Gas Co., de., v. Kentucky Heating Co. (1909),

132 Ky. 435, 442; Rich v. Doneghey (1918), 71 Okla. 204;

Frost-Johnson Lumber Co. vy. Salling’s Heirs (1920), 150

La. 756; Watford Oil & Gas Co. v. Shipman (1908), 233 Ill.

9; Wagner v. Mallory (1902), 169 N. Y. 501, 505; Kelley v.

The Ohio Oil Co. (1897), 57 Ohio 317, 328, The question

had not been definitely determined in the States of Ten-

nessee, Kansas, Arkansas, Pennsylvania, California, and

West Virginia. 1 Tex. Law Review, 163, 170-178,

ey a

15

practically a universal rule that the lessee under

a lease which grants, leases, and lets the realty for

the sole purpose of mining and operating for oil

and gas, and producing and saving such products,

acquired no title to such oil and gas until it was

reduced to possession. Thornton, Oil and Gas

(4th Edition), Sections 36, 57. This was likewise

the rule in Texas (Young v. Jones, 222 8S. W. 691),

although a change occurred in 1923 by the deci-

sion of the Supreme Court of Texas in Stephens

County v. Oil & Gas Co., 113 Tex. 160.’

The section of the statute here involved does. not

indicate any intent to depart from this well-estab-

lished rule. On the contrary, applying well-settled

principles of construction, Congress is presumed to

have legislated with the settled principles appli-

cable to mineral leases in mind (United States v.

Merriam, 263 U. 8. 179, 187), and must be pre-

sumed to have used the term “‘sale” in its usual,

ordinary, and every-day meaning (Old Colony R.

Co. v. Commissioner, 284 U. 8. 552, 561). It is not

to be presumed that Congress used the word in a

sense not applicable to oil and mining leases under

established law and usage recognized and declared

by the decisions of the courts. Since a lease like the

*Tewas Co. v. Daugherty, 107 Tex. 226, 234, decided in

1915, was generally understood as resting upon the form

of the “lease” in that case, which was in terms a convey-

ance of the oil and gas in place. 18 Mich. Law Review, 757.

Jones v. Murphy (1923), 253 S. W. 634, did not apply the

rule of Z'ewas Co. v. Daugherty. :

a

one involved in the case at bar was understood at

the time of the enactment of the law as a lease and

not as a conveyance, Congress could not have in-

tended that such a lease should be comprehended

within the meaning of the term ‘‘sale.”’

In Burkett v. Commissioner, supra, dealing with

the same question here involved under the similar

provisions of the Revenue Act of 1921, the court

said (p. 668) :

Whether this instrument [an oil and gas

lease in Arkansas] can be described by any

defined legal terms—such as lease, license,

ete.—it is certain that it is only a limited

grant of a right in respect to land and for

a limited period of time by one having the

fee and possession. Such can not be denom-

inated a sale in the ordinary sense of that

word, and there is no reason to construe

section 206 as using ‘‘sale’’ in any other

sense. The wording and the legislative his-

tory of section 206 are clear that it was in-

tended to apply to ‘‘sales’’ in the sense of

conveyance of title to property, not the

creation of privileges or estates or rights in

property for a limited period of time.

The purpose of Congress in enacting the provi-

sions as to gains arising from the sale of capital

assets indicates that the construction for which

we contend is correct. Prior to 1921 gains and

profits representing the increased value of prop-

erty were taxed as a lump sum in the year in which

the property was sold and the gain realized. Thus,

16

—_

17

although this property represented the realization

of a gradual appreciation of value extending over

several years, the effect of the statute was to con-

centrate the gain and the tax in a single year. The

profits often reached the upper surtax brackets and

became subject to high rates of taxation. Conse-

quently, the specter of the tax had the effect of

inducing the owners of such property to withhold

it from sale. The capital-gains provisions were

adopted to relieve this situation. See Alexander v.

King, 46 F. (2d) 235 (C. C. A. 10th), eraniaiand de-

nied, 283 U. 8. 845."

The Revenue Act of 1924 continued the provi-

sion of the 1921 Act with respect to the tax upon the

sale of capital assets, but, although some modifica-

tions were made," there is no indication in the legis-

lative history of an intent to bring oil and gas leases

within its provisions.

The statute does not define the cerns ‘*sale’’

‘capital assets’’ is defined generally, with wee

tions not here pertinent, as property held by the

taxpayer for more than two years. (See Section

208 (a) (8), supra, p. 3.) But definition is not

necessary in order to determine a question of classi-

fication where the purpose of Congress is reason-

ably clear. Bowers v. Lawyers Mortgage Co., 285

10 See H. R. 350, 67th Congress, 1st Session, pp. 10-11.

1H. R. 179, 68th Cong., Ist Sess., pp. 19-20; S. R. 398,

68th Cong., ist Sess., pp. 21-22; Conference Report No.

844, to accompany H. R. 6715, 68th Cong., Ist Sess., p. 15.

— ABS BEERS OAR SIE IE OME EIS SMART

18

U.S. 182, 187. There can be no doubt that the sole

purpose of Congress was to encourage the “‘sale’’ of

property which was being held off the market on

aecount of the tax situation.

The term ‘“‘sale of capital assets’’ aptly describes

the transfer of property whereby the owner parts

with his entire interest for a consideration. The

term does not describe a lease under which the les-

sor retains an interest in the land. The owner of

oil lands needed no encouragement from the statute

to lease his lands, for there could be no capital gain

realized from the enhanced value of the property

subject to tax. The tax fell only upon the income

in the form of a bonus and royalties when received

under the lease. The owner was deterred by the

existing statutes (prior to the Revenue Act of

1921) from selling his land and thus realizing a

capital gain, not from leasing his lands and re-

ceiving income in the form of rent or royalties.

In view of the purpose of Congress to encourage

*“‘sales’’ resulting in the realization of capital

gains, the statute should not be construed to cover

transactions not within its purpose or within its

meaning under the law at the time of its enactment.

It is a familiar rule of statutory construction

that the terms used by Congress must be read in

the light of, and in an endeavor to effectuate, the

objects and purposes for which the statute was

enacted, and that to this end the condition of affairs

which led to the legislation may be considered.

. rere — —

19

American Tobacco Co. v. Werckmeister, 207 U.S.

984, 293. This principle of construction is not im-

paired by the rule that doubts in taxing statutes

are to be resolved against the Government. The

question here is not whether the gain from the

transaction is embraced within the taxing statute;

it is whether respondent is entitled to a more favor-

able rate than if the transaction were treated as

Congress must have intended it to be in view of

the considerations stated above. Thus, the situa-

tion is analogous to that where an exemption from

taxation is claimed. In such cases the rule requires

that the taxpayer be held liable for the tax unless

clearly shown to be within the more favored class.

Bowers v. Lawyers Mortgage Co., supra. More-

over, as was said in Baltimore Talking Board Co.

y. Miles, 280 Fed. 658 (C. C. A. 4th), certiorari

denied, 259 U. S. 587, before a doubtful statute may

be given a construction favorable to the taxpayer

(p. 661) ‘‘the doubt as to the meaning of the statute

must be one which remains after all recognized

rules for ascertaining its meaning have been tried.”’

We believe that in holding that the construction

_of this statute was controlled by State decisions the

court below disregarded the principles of construc-

tion to which we have referred in this part of the

argument, and also certain other established prin-

ciples which we discuss under the succeeding point.

oo

20

III

THE STATUTE DOES NOT MAKD ITS APPLICATION DEPEND.

ENT UPON STATE RULES AS TO THR EFFECT OF OIL

LEASES BETWEEN THE PARTIES THERETO, AND THERE-

FORE SUCH STATE RULES MUST BE DISREGARDED IN

APPLYING THE STATUTE

Until the decision of the court below in Ferguson

v. Commissioner, supra, 45 F. (2d) 573, the deci-

sion of this Court in Von Baumbach v. Sargent

Land Co., supra, 242 U. 8. 503, was generally ac-

cepted as decisive that the State law defining the

effect of a mining lease need not be followed in de-

termining whether the consideration received un-

der such lease constituted income or proceeds from

the sale of capital assets under the Federal reve-

nue laws. Rosenberger v. McCaughn, 25 F. (2d)

699 (C. C. A. 3d), certiorari denied, 278 U. S. 604;

Bankers Pocahontas Coal Co. v. Commissioner, 55

F. (2d) 626 (C. CO. A. 4th), now pending in this

Court on petition for a writ of certiorari, No. 104,

October Term, 1932; Hirschi v. United States, su-

pra, 67 C. Cls. 637, certiorari denied, 280 U. 8. 576.

See also Jamison Coal & Coke Co. v. Commissioner,

24 B. T. A. 554, 570.

In Von Baumbach v. Sargent Land Co., supra,

the Government contended, in part, that the estab- '

lished law of the State with respect to the charac-

ter of a mining lease should be followed.” But

this Court said (pp. 518-519) :

* The State law did not treat such leases as sales. The

Circuit Court of Appeals had applied the Pennsylvania rule

that such leases constituted sales. Its decision was reversed.

(242 U. S. 517.)

—_

21

Ordinarily, and as between private parties,

there is no question of the duty of the

federal court to follow these decisions of the

Minnesota Supreme Court, as a rule of real

property long established by state decisions.

Kuhn v. Fairmont Coal Company, 215 U.

S. 349, 360. Whether in considering this

federal statute we should be constrained to

follow the established law of the State, as

is contended by the Government, we do not

need to determine. The decisive question

in this case is whether the payments made as

so-called royalties amount to income so as to

bring such payments within the scope of the

Corporation Tax Act of 1909. The prior

decisions of this court in Stratton’s Inde-

pendence Vv. Howbert, 231 U. 8. 399, and

Stanton v. Baltic Mining Company, 240

U. S. 103, in which the Stratton Case was

followed and approved, are decisive of this

question. ;

In Rosenberger v. McCaughn, supra, which

arose under the law of Pennsylvania, where a lease

of coal lands is treated as a sale of coal in place,

the court said (p. 701) :

Wholly aside from the construction which

the Minnesota courts had placed upon instru-

ments of that kind and solely because of the

nature of the payments themselves, the Su-

preme Court, as we read its opinion [in

Von Baumbach v. Sargent Land Co. held

that the instrument there in question did not

effect a sale of the property * * *.

In Bankers Pocohontas Co. v. Commissioner,

supra, which arose under the law of West Virginia,

where the local rule was not clearly established

but was assumed to be similar to the Pennsylvania

rule, the court, in following the Rosenberger case,

said that in that case (p. 629)—

it was pointed out that in Von Baumbach v.

Sargent Land Company, supra, the Supreme

Court had reached the conclusion that roy-

alties from mines constituted taxable income

wholly aside from the construction placed

by the Minnesota courts upon mining leases.

The Supreme Court declined to review this

interpretation of its decision when it denied

certiorari.

In Hirschi v. United States, supra, which arose

under the law of Texas, and presented the identical

question involved in the instant case, the Court of

Claims, in reliance upon the rule in the Von Baum-

bach case held that a cash bonus paid to a lessor

of Texas oil lands was not ‘‘a capital gain”’ but

“‘ordinary income.”

Even if the decisions which have treated the con-

clusion of this Court in the Von Baumbach case as

deciding that local rules as to the nature of mineral

leases do not control in the construction and appli-

cation of the Federal Revenue Acts are laid aside

and the question is to be considered as stil] open,

we believe that there is no basis for treating the

peculiar rules applied to oil leases by the Texas

courts as requiring a special and unusual construc-

22

23

tion of the statute when applied to the considera-

tior paid therefor. If the income from an oil and

gas lease is to be classified as capital gain when the

transaction takes place in Texas but as ordinary in-

come when the transaction occurs in any other

State, it is at once apparent that Texas taxpayers

will be favored in a way not contemplated by Con-

gress. It is reasonable to suppose that Congress

intended the statute to be uniformly applied, since

the desirability of the uniform application of Fed-

eral statutes is generally recognized. Calhoun

Gold M. Co. v. Ajax Gold M. Co., 182 U. 8. 499, 505;

United States v. Childs, 266 U. S. 304, 309; Burk-

Waggoner Oil Assn. v. Hopkins, 269 U. 8. 110;

Weiss v. Wiener, 279 U. S. 333; Boston & Maine

R. R. v. United States, 265 Fed. 578 (C. C. A. 1st),

certiorari denied, 255 U. 8. 577; Hagan v. Commis-

sioner, 43 F. (2d) 881, 883 (C. C. A. 5th. Espe-

cially is this true where the rights involved arise

under the laws or Constitution of the United States.

Under such circumstances it is well settled that the

Federal courts are not bound by local law. Cres-

cent Live Stock Co. v. Butchers’ Union, 120 U. 8.

141, 159; Guffey v. Smith, 237 U.S. 101, 114. See

also Black & White Taxicab Co. v. Brown & Yellow

Taxicab Co., 276 U. 8. 518. This rule has often

been applied in tax cases.”

18 Fidclity-Philadelphia Trust Co. vy. Commissioner, 47 F.

(2d) 36, 88 (C. C. A. 3d); First Nat. Bank in Dallas v.

Commissioner, 45 F. (2d) 509 (C. C. A. 5th), certiorari

denied, 283 U. S. 845; Osburn California Corp. v. Welch,

39 F. (2d) 41 (C. C. A. 9th), certiorari denied, 282 U. S.

24

From an examination of the decisions of this

Court we take it to be well settled that the interpre-

tation of a Federal tax statute is quite beyond the

reach of local rules unless it is so drawn as to make

its application dependent on peculiar incidents and

characteristics of property which are necessarily

determined by State law. If the application of the

Federal statute is made dependent upon such condi-

tions, either expressly or by implication, then neces-

sarily the Federal courts in applying it must look

to the local rule of the State to determine those

characteristics. Rosenberger v. M cCaughn, 25 F.,

(2d) 669 (C. C. A. 3d), certiorari denied, 278 U. S.

604. Such was the situation in Crooks v. Harrel-

son, 282 U. S. 55; Poe v. Seaborn, 282 U. S. 101;

United States v. Cambridge Loan & Bldg. Co., 278

U.S. 55; and Tyler v. United States, 281 U.S. 497.

In Crooks v. Harrelson, supra, where a Federal

statute imposed a tax upon the transfer of the net

estate of a decedent ‘To the extent of the interest

therein of the decedent at the time of his death

which after his death is subject to the payment of

the charges against his estate and the expenses of

850; California Iron Yards Co. v. Commissioner, 47 F, (2d)

514, 516 (C. C. A. 9th); Aldridge v. United States, 64

C. Cls. 424; White v. Hornblower, 27 F. (2d) 777 (C. C. A.

Ist) ; Hart v. Commissioner, 54 F. (2d) 848 (C. C. A. 1st).

Cf. St. Louis Union Trust Co. v. Burnet (C. C. A. 8th),

decided May 18, 1932, 323 C. C. H. 8817, 8820.

This rule is also recognized by the Texas courts. Staley v.

Vaughn, 50S. W. (2d) 907 (Tex. Civ. App.).

VRPT ORE Tm —

25

its administration and is subject to distribution as

part of his estate,’’ only the local law could deter-

mine whether the property in question was subject

to the payment of charges against the estate and

the expenses of its administration, and resort was

accordingly had to the local law because the Fed-

eral statute was so drawn as to make it necessary.

In Poe v. Seaborn, supra, and the other commu-

nity property cases relied upon by the court below,

the statute imposed a tax ‘‘upon the net income of

every individual.’”’ This Court held that the word

‘‘of’? denoted ownership, and since the statute fur-

nished no other standard of determining whether

income belonged to an individual, resort was neces-

sarily had to the State law to determine whether

the wife also had an ownership in the income there

involved. The same problem was presented in

United States v. Robbins, 269 U. 8. 315, and United

States v. Malcolm, 282 U.S. 792.

In United States v. Cambridge Loan & Bldg.

Co., supra, the exemption in the Revenue Acts of

“domestic building and loan associations’? was

held to require reference to the local law, and this

Court said (p. 59):

The statutes speak of ‘‘domestic’’ associa-

tions, that is, associations sanctioned by the

several States. They must be taken to ac-

cept, with the qualifications expressly stated,

what the States are content to recognize,

unless there is a gross misuse of the name.

VRP LIA EPS IN, BE IO

26

Tyler v. United States, supra, is similarly dis-

tinguishable. In Bankers Pocahontas Coal Co. vy.

Commissioner, supra, the court said (p. 630) :

Reference is made to Tyler, Adm’r, v. United

States, 281 U. 8. 497; Crooks, Col., v. Har-

relson, 282 U. 8. 55; and Poe, Collector,

v. Seaborn, 282 U. 8. 101; but it is obvious

that each of these decisions turned upon the

fundamental question whether the property

sought to be taxed came within the purview

of the taxing statutes. When it was clear

that such was the case, the federal statute

was given effect, as in Tyler v. United States,

281U.8.497 * * *

The court below, however, seemed to think that

it was required to follow the State law in the in-

stant case because of this Court’s decision in

Group No, 1 Oil Corp. v. Bass, 283 U. 8. 279. It

is submitted, however, that that case is distinguish-

able. There the income was that of a lessee, de-

rived from the sale of oil and gas produced under

leases of public lands executed under the laws of

the State of Texas. Under the Constitution of the

State of Texas such public lands could only be dis-

posed of by sale. (See 283 U.S. at p. 281.) Im-

munity from the tax was claimed on the ground

that the income was derived from an instrumental-

ity of the State. On the other hand, the Govern-

ment contended in part that since under Texas

law, as between the State and lessee, the lessee was

a purchaser and the lease constituted a sale, the

27

tax did not fall on the State or an instrumentality

of the State but upon a private enterprise. It be-

came necessary, therefore, to determine what was

the actual fact as to the ownership of the property

which produced the income." If it was in fact the

property of the State it was constitutionally im-

mune from the tax. If it was in fact the property

of the lessee there was no immunity. As was said

in Burnet v. Coronado Oil & Gas Co., 285 U.S. 393,

399, the reason for resort to State law in the Group

No. 1 Oil Corp. case was because the ‘‘status of the

title was matter for determination under the laws

of the State as construed and applied by her

courts.””** In ose cases the decision depended

In this respect the Growp No. 1 Oil Corp. case is like

Poe v. Seaborn, supra.

15 In the Government’s brief in Group No. 1 Oil Corp. v.

Bass, supra, the reasons for applying local law to that case,

while it would be inapplicable to a case like Hirschi v.

United States, supra (which is precisely like the present

case), are stated as follows:

«“* * * We are aware of the rule that in applying a

Federal taxing statute this Court is not bound by the con-

struction of a local court but is free to make its own inter-

pretation of the nature of any instrument under considera-

tion. Von Baumbach v. Sargent Land Co., 242 U. S. 503,

518-519; Burk-Waggoner Assn. v. Hopkins, 269 U. S. 110,

114; B. & W. Tawi. Co. v. B. & Y. Tawi, Co., 276 U. S. 518,

530. This principle is applicable in situations analogous to

those in Hirschi v. United States, 67 C. Cls. 637, certiorari

denied, 280 U. S. 576, and Burkett v. Commissioner, 31 F.

(2d) 667 (C. C. A. 8th), certiorari denied, 280 U. S. 565,

where the controversy turned upon whether or not the tax-

payers’ incomes were within the terms of the Federal tax-

ing statute there in question. On the other hand, however,

— —— ——

i

28

on the relationship that the particular State bore to

the land from which the income was derived. So

far as the United States was concerned, that was a

question between ‘‘private parties’’ in the decision

of which local law controls. Of, Von Baumbach v.

Sargent Land Co., supra. If under the local law

the State had sold its property to others, it was

held that the effect of a Federal tax upon the in-

come of the purchaser could be disregarded, while

the contrary was held if the State retained a pro-

prietary interest.

There is no question here of determining the re-

lation between the State of Texas and a lessee with

which it contracted. This case is concerned with

a lease made between private parties, and the ques-

tion is not whether a Federal tax imposes an un-

constitutional burden upon the State, but merely

whether the income produced by the lease is to be

put in one class or another. The classification is

made by a Federal statute. The power of Con-

gress to make a classification satisfactory to itself

without regard to State law must be conceded, and

where the point in controversy relates to property rights

as between two contracting parties, the rule of the local

court will be followed in the Federal courts. Von Baum-

bach v. Sargent Land Co., supra; Waggoner Estate v.

Wichita County, 273 U. S. 113, 117. Accordingly, so far as

the relationship between petitioner and its lessor is con-

cerned, the interpretation of the Texas court is deemed to

be controlling.”

SNORE Fa Oe” wpieay Pe PT ro

29

we are concerned only with the intention and pur-

pose of the statute.

Unlike the statutes involved in the cases where

resort was had to the local law, Congress has not

indicated any purpose that the classification of

‘ordinary income”’ and ‘‘capital gains’’ should de-

pend upon local law. General terms are used which

are well understood. Reference to local law is not

necessary to enable the taxing authorities or the

courts to determine where the tax falls, for the

criteria necessary to decision are all established by

the statute when read in the light of the decisions of

this Court cited supra, pp. 12-14. Treatment of the

bonus received by respondent as ‘‘ordinary income”’

instead of ‘‘capital gain’’ leads to no conflict be-

tween Federal law and State law. On the contrary,

such conclusion is predicated upon a Federal stat-

ute which, in the absence of any indication of a pur-

pose that the incidence of the tax should vary with

artificial variations of the local laws of the various

States, must be held to contain its own criteria based

upon familiar rules established by this Court. Ac-

cordingly, we think that the local rule must be disre-

garded as was done in Weiss v. Wiener, 279 U. S.

333; Burk-Waggoner Oil Assn. v. Hopkins, 269

U.S. 110.

In Weiss v. Wiener, supra, a Federal statute

granting a deduction of ‘‘a reasonable allowance

for the exhaustion, wear and tear of the property

used in the trade or business’’ was involved. Wie-

ner was a lessee and sought an allowance for de-

—_— NTSC NLU RN RRO TAN

30

preciation of property held under a ninety-nine-

year lease, renewable forever, which under the local

law was treated as in many respects like a convey-

ance of the fee. The deduction was denied, and

this Court refused to follow the local law, saying

(p. 337) :

It does not matter that in Ohio, were the

properties lie, these long leases ar: treated

as in many respects like conveyances of the

fee. The Act of Congress has its own cri-

teria, irrespective of local law, that look to

certain rather severe tests of liability and

exemption and that do not allow the deduc-

tions demanded whatever the lessees [leases ]

may be called.

In Burk-Waggoner Oil Assn. v. Hopkins, supra,

it was sought to tax as a corporation a joint-stock

association which, under the law of Texas, was not

recognized as a legal entity but was deemed to be a

partnership. The Federal statute did not define

the term “‘joint-stock association” but simply clas-

sified such an organization as a corporation. This

Court said (p. 114):

It is true that Congress can not convert

into a corporation an organization which by

the law of its State is deemed to be a partner-

ship. But nothing in the Constitution pre-

cludes Congress from taxing as a corporation

an association which, although unincorpo-

rated, transacts its business as if it were in-

corporated. The power of Congress so to

tax associations is not affected by the fact

——

31

that, under the law of a particular State, the

association can not hold title to property, or

that its shareholders are individually liable

for the association’s debts, or that it is not

recognized as a legal entity. Neither the

conception of unincorporated associations

prevailing under the local law, nor the rela-

tion under that law of the association to its

shareholders, nor their relation to each other

and to outsiders, is of legal significance as

bearing upon the power of Congress to de-

termine how and at what rate the income of

the joint enterprise shall be taxed.

In the decision in the Ferguson case, supra, 45

F. (2d) 573, 575, reference is made to the collec-

tion of stamp taxes upon oil leases in the State of

Texas under the provisions of the Revenue Act of

1921 (Schedule A, 6, Title XI) and the cor-

responding provisions of the Revenue Act of 1924

(Schedule A, 5, Title VIII, U. 8. C., Title 26, See.

901). It is said to be inconsistent to classify these

leases as ‘‘conveyances * * * whereby any

lands, tenements, or other realty sold shall be

granted, assigned, transferred, or otherwise con-

veyed to, or vested in, the purchaser or purchasers

* * *»? and at the same time to deny that such

leases are sales of capital assets. Ar‘icle 29 of Reg-

ulations 55 provides as follows:

What constitutes ‘‘lands, tenements, or

other realty’’ is determinable by the law of

the State in which the property is situated.

Standing timber is ordinarily held to be real

estate, and where so held th deed trans-

ferring it is subject to the tax.

32

Since oil and gas leases are treated by the Texas

decisions as conveyances of real estate, the stamp

tax was properly collected unless the provision of

the regulations that the local law controls is er-

roneous. The regulations with respect to capital

gains do not purport to make the local law applica-

ble, and whether Regulations 55 properly construes

the stamp-tax statute is not in question here. Put-

ting the Texas decisions aside, it is still true that

even though an oil and gas lease does not amount to

a conveyance of the oil and gas in the ground, it

does amount to a conveyance of an interest in the

land. Ewert v. Robinson, 289 Fed. 740, 750 (C. C.

A. 8th). This Court is not now called upon to de-

cide whether the stamp tax was properly collected,

and if the Treasury Department has been inconsist-

ent and the distinction which has been made is un-

sound, that should not prevent the application of

the correct rule in the present case.

CONCLUSION

It is respectfully submitted that the decision of

the court below should be reversed.

THomas D. THACHER,

Solicitor General.

G. A. YouNGQuvUIST,

Assistant Attorney General.

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SEWALL Key,

A. H. Conner,

Special Assistants to the Attorney General.

SEPTEMBER, 1932.

U. S. GOVERNMENT PRINTING OFFICE: 1932

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