Reply Brief — Burnet v. Harmel

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FILE COPY

IN THE

Supreme Court of the United States

Octoser Term, 1931.

nm OG

Daviw Burnet, Commissioner oF InTERNAL REVENUE,

Petitioner,

vs.

Henry HarMeE..

Reply to Petition for a Writ of Certiorari to the United

States Circuit Court of Appeals for the Fifth Circuit.

‘Reenet AsuH,

Munsey Building,

Washington, D. C.,

Attorney for Henry Harmel.

Press or Brrox 8. Apams, WasHIneron, D. O.

RAPS * AS Vey AE TE a

7-7"

INDEX.

Page

Question Presented ............seeeeereeceeeeeeces 1

NG gg yaa beds oe Neg WENO S Cadcewane Seed oeaees 2

SS PEI SIE EOP TELE IT PT TOOT ET TTT eT Teer eT 2

BOOTIE 6k 6 eevee ccccsccsesceceseneewasseesenes 4

EE OP REE COLO OL OTE R ECCC CTE TOLER Ore 11

TABLE OF CASES CITED.

Alexander v. King, 46 F. (2d) 235 ................ 8

Bankers Pocahontas Coal Co. v. Commissioner, 55 F

SE ch. Kos Sh akwieh buna tree earns cecae pees 8

Berg v. Commissioner, 33 F. (2d) 641 .............. 8

Burk-Waggoner Oil Assn. v. Hopkins, 269 U. 8. 110 8

Burkett v. Commissioner, 31 F. (2d) 667 .......... 8

Ferguson v. Commissioner, 45 F. (2d) 573........ 4-5, 11

Group No. 1 Oil Corp. v. Bass, 283 U. S. 279........ 5

Re ee OG ee ee ey ere eer ae 4

Murphy v. Commissioner, 2 Prentice-Hall 1930, p.

a a ee rene a 7

POS Vy We Uc Te DOE kiccg ic vce sensnccpnsivus 6

Reynolds v. Commissioner, 10 B. T. A. 651, affirmed

Ce Sc a ee Sy PE ks chon wensadcaanes 8

Pee ©. US, Ty Bee Bis OD ee aw tive ks sn oeecces 6

Rosenberger v. McCaughn, 25 F. (2d) 699 .......... 8

Stanton v. Baltic Mining Co., 240 U. S. 103.......... 5, 6

Stephens County v. Oil & Gas Co., 113 Texas 160 .... 5

Stratton’s Independence v. Howbert, 231 U. S. 399.. 5, 6

Texas Company v. Daugherty, 107 Texas 226........ 5

Theisen v. Robison, 117 Texas 489 ................ 5

Tippett v. Commissioner, 25 B. T. A. 69 ............ 11

U. S. v. Biwabik Mining Co., 247 U.S. 116 .......... 5, 6

Se eee ee NE Sls We FOIE eae co vpawsine nccnsas 6

VonBaumbach v. Sargent Land Co., 242 U. S. 503.... 5, 6

Waggoner, W. T., et al., v. Commissioner, 24 B. T.

ME bode Cel alee Vip dceabeeekohaehiee's « 11

Weiss v. Weiner, 279 U. 8. BEB... ccc ccc cee 9

mame ©. Member, B01 U. B. BER oon. cv ccccccdces 9

FEM ae BRAT ET OF PEE PINE NER RIN TRL ve RITE ANS OW Qe eg ree HTM: ROE OM IE One Toran s

IN THE

Supreme Court of the Anited States

|

Ocroser Term, 1931.

|

No. 824.

Daviw Burnet, Commissioner or InteRNAL Revenve,

Petitioner,

vs.

Henry HarMe..

Reply to Petition for a Writ of Certiorari to the United

States Circuit Court of Appeals for the Fifth Circuit.

QUESTION PRESENTED.

The question presented is whether a cash consideration

received by the owner cf lands situated in Texas for the

execution of an instrument commonly known as an ‘‘oil

and gas lease,’’ which, under the law of Texas conveys

title to the oil and gas in place, is taxable as the ‘‘gain

derived from the sale or exchange of capital assets’’ un-

der Section 208 of the Revenue Act of 1924. ‘Capital

assets’’ are defined in the statute as ‘‘property held by

the taxpayer for more than two years.”’

— a — ——

—

It is admitted that the cash received is taxable income,

If it is income from the sale of capital assets it is taxable

at the flat rate of 12% per cent provided in Section 208.

No question is presented regarding the taxing of any

royalties which may have been received under the instru-

ment,

STATUTES.

Revenve Act or 1924:

“Sec, 208. (a) For the purpose of this title—

**(1) The term ‘capital gain’ means taxable gain from

the sale or exchange of capital assets consummated after

December 31, 1921; * * *

**(8) The term ‘capital assets’ means property held

by the taxpayer for more than two years (whether or not

connected with his trade or business), but does not in-

clude stock in trade of the taxpayer or other property of

a kind which would properly be included in the inventory

of the tax-payer 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 corpora-

tion) who for any taxable year derives a capital net gain,

there shall (at the election of the taxpayer) be levied, col-

lected and paid, in lieu of the taxes imposed 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 210 and 211, and the total tax shall

be this amount plus 12% per centum of the capital net

gain.’’

STATEMENT.

The Respondent, Henry Harmel, resides at Megargel,

Texas. In 1924 he was, and had been for many years,

the owner in fee simple of certain lands located in

CERN 8s RMI CRN PNR IE AY oY —

Archer County, Texas. In 1924 he executed two oil and

gas leases (R. 25-34) covering the land. In consideration

therefor he received $57,000.00 in cash.

The Respondent, in his income tax return for 1924,

treated this entire sum as capital gain under Section 208

of the Revenue Act of 1924. The Commissioner of In-

ternal Revenue held it was not capital gain and was tax-

able at ordinary rates. The Board of Tax Appeals

affirmed the Commissioner (R. 14-18), 19 B. T. A. 376, and

the Circuit Court of Appeals for the Fifth Circuit re-

versed the Board (R. 35-36).

One of the instruments in question provides that the

Respondent, styled Lessor, ‘‘for and in consideration of

Twenty Thousand and no/100 Dollars, and other consid-

erations hereinafter set forth cash in hand paid, the

receipt of which is hereby acknowledged, and of the

covenants and agreements hereinafter contained on the

part of the lessee to be paid, kept and performed, has

granted, demised, leased and let, and by these presents

does grant, lease and let, etc.’’ (Record 25-26)

The other considerations referred to are stated in the

instrument to be: ‘‘The other consideration above men-

tioned is the sum of $20,000.00 which shall be paid to the

lessor hereof out of one-half of seven-eighths of the first

oil produced on said land.’’ (Record 29)

The other instrument provides ‘‘That the said lessor,

for and in consideration of Forty-four Thousand and

no/100 Dollars cash in hand paid, and the consideration

hereinafter named, receipt of which is hereby acknowl-

edged and of the covenants and agreements hereinafter

contained on the part of the lessee to be paid, kept and

performed, has granted, conveyed, demised, leased and

let, and by these presents do grant, convey, demise, lease

and let, ete.’ (Record 30)

The further consideration referred to in this instance

was $44,000.00 to be paid the lessor ‘‘out of one-half of

seven-eighths of the first oil produced from said land

—_—_—_ er a inne aaa me OF MIRE A RN EAST OSPR RPT

4

and a vendor’s lien is retained against said leasehold

estate and the oil produced therefrom until the full sum

of Forty-four Thousand Dollars is paid.”’ (Record 33)

Kach instrument provides.for royalties as follows:

(a) one-eighth of all oil produced;

(b) One-eighth of the value at the well of gas pro-

duced from gas wells; and

(c) One-eighth of the value of gas produced from

oil wells and used off the premises,

(Record 26, 27, 31)

ARGUMENT.

1,

The petitioner predicates his application for a writ in

this case upon the conflict of the decision below with the

decision of the Court of Claims in Hirschi v. United

States, 67 Ct. Cls. 637 (decided May 6, 1929; certiorari

denied 280 U. S. 576). Since the Hirschi decision this

Court has settled the law which controls this case, as will

be shown hereafter. It is, therefore, submitted that this

conflict does not require the granting of the writ.

In this case the Court below held that the considera-

tion received by the Respondent for executing the instru-

ments set out in the statement was taxable at the flat rate

of 12% per cent as a “‘capital gain’’ under the Statute

(Sec. 208, Revenue Act of 1924) which defines ‘“capital

gain’’ as ‘‘taxable gain from the sale or exchange of cap-

ital assets’’ and then defines ‘‘capital assets” as ‘“prop-

erty held by the taxpayer for more than two years’’. The

Court reached this conclusion because of the settled law

of Texas that such an instrument conveyed to the so-

called lessee title to the oil and gas in place and was,

therefore, a ‘‘sale’’ within the terms of the Statute.

This opinion merely followed and re-affirmed the conclu.

sions reached by the same Court in 1930 in Ferguson v.

VS=—_"

5

Commissioner, 45 F. (2d) 573. The Government did not

ask for a rehearing nor for certiorari in the Ferguson

case.

In the Hirschi case, decided in 1929, the Court of

Claims held that such gains were not capital gains, but

were to be taxed at ordinary rates, refusing to give effect

to the Texas law and treating the question as foreclosed

by the decisions of this Court holding that the income

from mining operations was taxable under the 1909 Cor-

poration Excise Tax Law and the Revenue Act of 1913,

without deduction for the value of the ore in place (Strat-

ton’s Independence v. Howbert 231 U. 8. 399; Stanton

vy. Baltic Mining Co., 240 U. S. 103; VonBaumbach v. Sar-

gent Land Co. 242 U. S. 503; U. S. v. Biwabik: Mining

Co., 247 U. S. 116).

That the local law is to be applied to determine whether

or not a sale has taken place (in order to determine the

incidence of a Federal tax where Congress has not put

into the Aci criteria for determining the question) has

been quite recently decided by this Court in an almost

identical situation (Group No. 1, Oil Corporation v. Bass,

983 U. S. 279). In that case this Court, in determining

whether or not the income from the oil leases there in-

volved. was taxable under Federal Revenue Laws, held

that the oil leases there involved were ‘‘present sales to

the lessees, upon the execution of the leases, of the oil

and gas in place’? (page 281), upon the authority of

Theisen v. Robison, 117 Texas 489. This, the Court

said, was the settled law of Texas as announced in Texas

Company v. Daugherty, 107 Texas 226, and Stephens

County v. Oil € Gas Company, 113 Texas 160. Therefore

this Court held that the lessees were taxable upon the

income derived from the oil-producing operations con-

ducted on these lands even though the lands in question

were University lands belonging to the State of Texas

and, but for this rule, the income in question might have

been exempt from taxation.

——

6

This express recognition that State rules of property

must be looked to in determining the incidence of a Fed-

eral tax where, as here, the ownership of real estate is

the controlling question and Congress has not seen fit to

limit the general terms used, carries out the principle ap-

plied by this Court in the Community Property cases

(Poe » Seaborn, 282 U. S. 101, and other cases decided

the same day; U. S. v. Malcolm, 282 U. S. 792; compare

Robbins v. U. S., 269 U. 8. 315).

These very recent decisions by this Court so plainly

authorize and compel the conclusions reached by the

Court below, that it would appear unnecessary for this

Court to grant the writ prayed for in order to resolve

the conflict with the Hirschi case decided before the de-

cisions above referred to.

2.

It is further submitted that a conflict between the de-

cision of a Circuit Court of Appeals and the Court of

Claims is not a reason for granting a writ of certiorari

within Rule 38, paragraph 5 (b) of this Court.

3.

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

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

bach v. Sargent Land Co., 242 U. 8. 503; and U. S. v.

Biwabik Mining Co., 247 U.S. 116; are not in conflict with

the decision in this case. As heretofore stated, they

arose under the Corporation Excise Tax Law of 1909

and the Revenue Act of 1913. In none of these acts were

capital gains taxed differently from recurring gains. The

capital gains feature of the law was first introduced into

the Federal taxation in the Revenue Act of 1921, long

after these cases were decided.

All dealt with the income from mining operations and

not with transfers of mining property. The basic ques-

7

tions involved were entirely different. In some of the

cases the question was whether the Excise Tax Law ap-

plied to mining companies. In others the question was

whether the proceeds of ore mined constituted income

and whether such corporations were entitled to deduct

from the proceeds so received the value of the ore in

place in arriving at the income to be taxed. In the

Stanton case, under the Revenue Act of 1913, the ques-

tion was whether the failure to allow more than five per

cent of the value of the product for depletion rendered

the tax a direct one on property and unconstitutional. In

one case (Stratton’s Independence) the mine was owned

in fee. Sargent Land Co. was a lessor, and that case

dealt with royalties on ore extracted by the lessee. The

Biwabik Mining Company was a lessee and the precise

question was whether, under the 1909 Act, it had the right

to deduct from gross income the value in place,—not cost,

of the ore mined.

Plainly these decisions have no bearing upon the ques-

tion decided by the Court below, and the Lower Court’s

decision is not in conflict with them.

4.

The various decisions of other Circuit Courts and the

Court of Appeals of the District of Columbia cited by

the petitioner do not conflict. The majority of these, in-

stead of dealing with the question at issue here, deal with

the proper method of taxing the royalties received from

oil-producing operations. In fact, no showing was made

in this case as to whether any oil was ever produced under

the leases in question and the leases themselves show that

no royalties were to be paid except upon and as oil and/or

gas were actually produced. This is applicable to the

following cases cited by the Petitioner: Murphy v. Com-

missioner (App. D. C.), decided Feb. 20, 1930, and re-

ported at 2 Prentice-Hall 1930, p. 1963 affirming J. E.

——

8

Murphy v. Commissioner, 9 B. T. A. 610; Reynolds v.

Commissioner (App. D. C.), decided Feb. 20, 1930, with-

out opinion and affirming J. D. Reynolds v. Commissioner,

10 B. T. A. 651; Alexander v. King (C. ©. A. 10th), 46 F.

(2d) 233 (certiorari denied 283 U. S. 845).

While Burkett v. Commissioner, 31 F. (2d) 667, and

Berg v. Commissioner, 33 F. (2nd) 641, decided that the

consideration received for the execution of the oil leases

there involved were not to be taxed as capital gain, neither

conflicts with the decision below in this case because both

involved land in Arkansas and the courts which decided

those cases were not called upon to determine the basic

question here involved, that is,—What is conveyed by

such instruments in Texas?

5.

Rosenberger v. McCaughn (C. C. A. 3d), 25 F. (2nd)

699, and Bankers Pocahontas Coal Co. v. Commissioner

(C. C. A. 4th), 55 Fed. (2d) 626, dealt with the proper

method of taxing one who, prior to March 1, 1913, ac-

quired the right to receive royalties from a coal mine

upon payments received subsequent to March 1, 1913.

The question of taxing the proceeds from the transfer of

mining property is not involved. In each case it is clear

that the same result would have been reached had the or-

iginal leases (made before March 1, 1913) been considered

sales of the ore in place and the royalty payments the

consideration therefor, for certainly there is the same ele-

ment of profit in the deferred consideration when col-

lected.

6.

Burk-Waggoner Oil Association v. Hopkins, 269 U. 8.

110, presented an entirely different question. There it

was held that the fact that a joint stock association was,

under the law of Texas, a partnership, did not deprive

> SRS ere a -

9

Congress of the power to classify it as a corporation for

the purpose of imposing the tax and did not render

unconstitutional the tax upon its income. No question is

presented in the case at bar as to Congressional power.

Admittedly Congress could refuse to extend the benefits

of the capital gains sections to transactions like those

involved here, just as it refused to extend them to prop-

erty not owned for two years, or to ‘‘properiy held pri-

marily for sale in the course of his trade or business”’,

(Sec. 208(a)(8), Revenue Act of 1924). But until Con-

gress sees fit to limit the meaning of ‘‘sale or exchange”’

or ‘‘capital assets’’, the question presented in the Burk-

Waggoner case will not arise.

In Weiss v. Weiner, 279 U. 8. 333, it was expressly

stated that the Act of Congress had provided its own

criteria for determining under what circumstances depre-

ciation deductions would be allowed and, therefore, the

fact that, under the law of Ohio, long-term leases upon

real estate were treated in many respects like conveyances

of the fee was unimportant in determining te whom and

under what circumstances the statutory depreciation de-

ductions were to be allowed. The decision of the Court

below does not conflict with decisions like these.

7.

In Work vs. Mosier, 261 U. 8S. 352, the Court was deal-

ing neither with a problem of taxation nor with any local

law relating to oil and gas leases. Instead, the Court

was construing an ambiguous statute relating to the dis-

position of tribal lands and funds of the Osage Indians,

and resolved the ambiguity in a way thought more nearly

to carry out the congressional intention.

Congress, by Statute passed in 1906, had provided for

the division of the lands and funds of the Osage Indians

in Oklahoma Territory among the members of that Tribe,

the lands to be divided by selection. The same Act for-

bade the sale of oil and other minerals in the lands and

—

10

reserved these minerals, and the uses and benefits arising

therefrom, for the Tribe as a whole for a period of

twenty-five years, the Act providing that for that period

the royalties should be paid to the Tribe and that at the

end of the twenty-five year period the oil and other

minerals should become the property of the individual

allottees of the land, unless otherwise provided. It was

also provided that periodical distribution of the royalties

received should be made to the members of the Tribe and

that the amount of these royalties were to be fixed by

presidential decree.

The unforeseen condition which arose, as is disclosed

by the opinion of the Court, was that large sums were

received as bonuses in the sale of such leases, which

were made at public auction. In this situation it became

necessary for the Court to determine whether, under this

Statute, these bonuses should be distributed among tlie

members of the Tribe during the twenty-five year period,

or whether they should be withheld during such period

and, at the end thereof, go to the individual allottee from

whose land the oil was produced. It was clearly the pur-

pose of Congress that the benefits of such minerals as

might be developed under the entire land should go to the

Tribe as a whole during the twenty-five year period, and

not to those particular allottees who were fortunate

enough to receive as their allotment a tract of land "ater

discovered to contain minerals. Under these circum-

stances, the Court said (page 357) :

‘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 de

scribed by the latter term.’’

It was only by reaching this conclusion that the inten-

tion of Congress,—that the entire Tribe, rather than indi-

¥ ote

11

vidual allottees should share in all of the benefits obtained

from the minerals,—could be carried out.

We also call the Court’s particular attention to the

discussion of this case in Ferguson vs. Commissioner, 45

Fed. (2) 573, 576-7.

8.

The Board of Tax Appeals is now following the Fergu-

son decision in cases arising in Texas. Waggoner v.

Commissioner, 24 B. T, A. 657; Tippett v. Commissioner,

25 B. T. A. 69.

CONCLUSION.

The Court below followed the very recent rulings of this

Court in deciding the question presented, It weuld ap-

pear that there is no further room to question the sound-

ness of that decision and that, without further action by

this Court, the principles decided below in this case and

the Ferguson case, will be followed. Therefore, ft is

unnecessary for this Court to further review this case.

Rosert Asx,

Munsey Building,

Washington, D. C.,

Attorney for Henry Harmel.

April, 1932.