Amicus Curiae Brief — Burnet v. Harmel

Aiki et

PEER RNP UE MRE RS A ON

a —— ; _

FILE COPY ocr 18

IN THE

Supreme Court of the Anited states

OctToBER TERM, 1932

No. 26

Davin BURNET, COMMISSIONER OF INTERNAL

REVENUE, Petitioner

v.

HenrY HARMEL

ON WRIT OF CERTIORARI TO THE UNITED

STATES CIRCUIT COURT OF APPEALS

FOR THE FIFTH CIRCUIT

BRIEF OF WALTER E. BARTON

AS AMICUS CURIAE

Water E. Barton,

Investment Bldg., Washington, D. C.

Counsel for W. T. Waggoner and

Ella Waggoner, as Amicus Curiae.

HAYWORTH PRINTING COMPANY . WASHINGTON D C

INDEX

Motion for Leave to File Brief as Amicus Curiae...

Preliminary

Opinions Below

Jurisdiction

on Presented

Statute Involved

Statement

Summary of Argument

Argument

I. The Cash Consideration Received by the Respondent Was

Not a Royalty

II. The Cash Consideration Was Received by the Respondent

ba)

no ng

conan &

_

from the Sale of Oil and Gas in Place to the Lessee... «17

III. The Cash Consideration Is Taxable as Capital Gain... 27

Citations

Page

Cases:

Alexander v. King, 46 F. (2d) 235 12

Berg v. Commissioner, 33 F. (2d) 641 14

Burk Waggoner Oil Assn. v. Hopkins, 269 U. S. 110.................. 26

Burkett v. Commissioner, 31 F. (2d) 667 14

Burnet v. Coronado O. & G. Co., 285 U.S. 393... 9, 10, 20, 31

Crooks v. Harrelson, 282 U. 8. 55 8, 18, 24

Ewert v. Robinson, 289 F. (2d) 740 28

Ferguson v. Commissioner, 45 F. (2d) 57%................... 18, 14, 15, 30

Ferguson vy. Commissioner, 59 F. (2d) 891 : 12, 18

Finch v. Beyer, 94 Kan. 525 13

Five Per Cent Cases, 110 U. S. 471 17

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

8, 9, 10, 14, 20, 21, 22, 31

Guffey v. Smith, 237 U. 8. 112 8, 18

Hirschi v. U. S., 67 Ct. Cl. 637 9, 14, 17, 80, 81

Hoover v. McNeill, 102 Kan. 492 13

Kepner v. U. S., 195 U. 8. 100 17

Lynch v. Alworth Stephens Co., 267 U. 8. 864.0000 oncom 28

Nelson Land & Oil Co., Appeal of, 3 B. T. A. 816 ............. au» 8, 18

Osborn v. Ark. Tex. O. & G. Co., 108 Ark. 178... cccccccccmnoon 14

Pocahontas Coal Co. v. Commissioner, 55 F. (2d) 626............... 25

Poe v. Seaborn, 282 U. S. 101 8, 18, 23

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

Smith v. Root, 66 W. Va. 633 .. inapcnincegeicadnnaisimmnnsinmtign ae

- ——

Page

Stanton v. Baltic Mining Co., 240 U. S. 108 0. 9, 16

Stephens Co. v. Mid-Kansas 0. & G. Co., 113 Tex. 160

8, 18, 19, 30

Stephens v. Stephens, 292 S. W. 290 eae 30

Strattons’ Independence v. Howbert, 231 U. S. 899.0000... 9, 16

Texas Co. v. Daugherty, 107 Tex. 226 200000... 8, 18, 19

The Abbotsford v. Johnson, 98 U. S. 440 17

Theisen v. Robison, 117 Tex. 489 8, 14, 18, 19

Toothman v. Courtney, 62 W. Va. 167 18

U. S. v. Biwabik Min. Co., 147 U.S. 116 00 n.. 9, 15, 28

U. S. v. Cambridge L. & B. Co., 278 U. S. 56 ............... 8, 18, 28, 24

U. S. v. Malcolm, 282 U. S. 792 8, 18, 24

U. S. v. Merriam, 263 U. S. 179 8,17

U. S. v. Robbins, 269 U. S. 315 8, 18, 24

Von Baumbach v. Sargent Land Co., 242 U. S. 503......... 9, 15, 28

Waggoner Est. v. Wichita Co., 273 U. S. 118 ooo... 8, 18, 19

Ween, We. Tuy GR Gl, BE TE. Ti A GE ines ecennticnss 4

Weiss v. Weiner, 279 U. S. 333 schcthaidions a

Williamson v. Berry, 8 How. 495 abnalinicksdacsstakeitacaalsuisiancabaickiientecia 18

Work v. Mosier, 261 U. S. 232 we 8, 10, 11, 14

Statutes:

Revenue Act of 1924—

Sec. 208 (a) 5

Sec. 208 (b) .............. 1

Textbooks:

25 Corpus Juris 839 8, 18

40 Corpus Juris 903 29

50 Corpus Juris 749 ovis 29

55 Corpus Juris 36 8, 17

22 Ruling Case Law 58 —_ wey

23 Ruling Case Law 1186 Fis TN Oe Pa ST OS ce 8, 17

27 Ruling Case Law 51 8, 18

Ay Ss Oe re Cie BL) GI ekki. 27

4 Words & Phrases (2nd Ser.) 436 17

6 Words & Phrases (3rd Ser.) 907 ........ 17

IN THE

Supreme Court of the Anited States

OcToBER TERM, 1932

No. 26

Davin BuRNET, COMMISSIONER OF INTERNAL

REVENUE, Petitioner

Vv.

Henry HarRMEL

ON WRIT OF CERTIORARI TO THE UNITED

STATES CIRCUIT COURT OF APPEALS

FOR THE FIFTH CIRCUIT

MOTION FOR LEAVE TO FILE BRIEF AS

AMICUS CURIAE

May it please the Court:

The undersigned, as counsel for W. T. Wag-

goner and Ella Waggoner, respectfully moves this

Honorable Court for leave to file the accompany-

ing brief in this case as amicus curiae.

Water E. Barton,

Investment Bldg., Washington, D. C.

Counsel for W. T. Waggoner and

Ella Waggoner, as Amicus Curiae.

1

bad an

IN THE

Supreme Court of the Anited States

OcToBER TERM, 1932

No. 26

David BURNFT, COMMISSIONER OF INTERNAL

REVENUE, Petitioner

v.

Henry HarMeEL

ON WRIT OF CERTIORARI TO THE UNITED

STATES CIRCUIT COURT OF APPEALS

FOR THE FIFTH CIRCUIT

BRIEF OF WALTER E. BARTON

AS AMICUS CURIAE

PRELIMINARY

W. T. Waggoner and Ella Waggoner filed ap-

peals from the Commissioner of Internal Revenue

to the United States Board of Tax Appeals, rais-

ing the question of whether cash considerations re-

ceived by them in 1922 for the execution of certain

instruments, commonly known as “‘oil and gas

leases,’’ on lands owned by them in Texas, which,

under the law of Texas, actually conveyed title to

the oil and gas in place to the lessee, were taxable

gain within the purview of Section 206 of the

3

BILLETS NER.

a

Revenue Act of 1921. The Board of Tax Appeals

held that such cash considerations were taxable as

capital gain and not as ordinary income. ( W. T.

Waggoner et al., Docket Nos. 33516, 33517, 24 B.

T. A. 657.) The Commissioner of Internal Reve-

nue has filed with the Buard of Tax Appeals a

petition to the United States Circuit Court of

Appeals for the Fifth Cireuit for review of the

order of the United States Board of Tax Appeals,

which petition for review has not yet been docketed

in the Cireuit Court of Appeals for the Fifth

Circuit.

The same question that is raised in the instant

case is presented in W. T. Waggoner et al., supra,

and the decision of this Court in the former will

determine the issue in the latter.

We shall attempt to show that the judgment of

the court below in the instant case should be af-

firmed.

OPINIONS BELOW

The opinion of the Cirevit 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.

J URISDICTION

The judgment of the Cireuit 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-

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

Judicial Code, as amended by the Act of February

13, 1925.

4

—

QUESTION PRESENTED

The petitioner states the question to be whether

cash bonuses paid as advance royalties under oil

and gas leases on lands in the State of Texas con-

stitute income from the sale of capital assets

within the meaning of Section 208 of the Revenue

Act of 1924. (Petitioner’s brief, p. 2.)

The findings of the Board of Tax Appeals were

that the respondent received ‘‘stipulated royalties

and a cash consideration of $57,000.00.” (R. 8.)

The opinion of the Board (R. 9) and the opinion

of the Circuit Court of Appeals for the Fifth Cir-

cuit (R. 20) refer to the $57,000.00 received as

“cash consideration”? and not as ‘‘advance roy-

alties.’’

It is respectfully represented that the question

presented is:

Whether a cash consideration received by the

owner of lands situated in Texas, for the execution

of an instrument commonly known as an “‘oil and

gas lease,”’ which, under the law of Texas, actually

conveys title to the oil and gas in place to the

lessee, is taxable as capital gain under Section 208

of the Revenue Act of 1924?

Statute INVOLVED

Revenue Act of 1924, c. 234, 43 Stat. 253, 162:

Sec. 208 (a) For the purposes of this title—

(1) The term “‘capital gain’’ means taxable

gain from the sale or exchange of capital as-

sets consummated after December 31, 1921;

(2) The term “capital loss’? means deduc-

tible loss resulting from the sale or exchange

of capital assets;

5

a

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

such deductions as are allowed by section 214

for the purpose of computing net income, 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 deductions ;

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

excess of the total amount of capital gain over

the sum of (A) the capital deductions 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 ir. accordance with

the provisions of this title, after excluding all

items of capital gain, capital 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.

6

(b) In the case of any taxpayer (other

than a corporation) who for any taxable year

derives a capital net gein, there shall (at the

election of the taxpayer) be levied, collected

and paid, in lieu of the taxes imposed by sec-

tions 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 1214 per centum of the capital

net gain.

* * * * * ae

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

STATEMENT

The respondent is an individual residing at

Megargel, Texas. (R. 8.) In the year 1924 the

respondent was, and had been for many years, the

owner in fee simple of certain land in Texas.

(R. 8.) In October, 1924, he executed two instru-

ments, commonly known as ‘‘oil and gas leases,”’

covering said land, on the basis of stipulated roy-

alties and a cash consideration of $57,000.00. (R. 8.)

This cash consideration was returned by respond-

ent as gain from the sale of capital assets under See-

tion 208, Revenue Act of 1924. (R.9.) The Com-

missioner of Internal Revenue treated it as income

taxable at the ordinary rates. (R. 9.) The Board

of Tax Appeals held with the Commissioner

(R. 9.), and the Circuit Court of Appeals for the

Fifth Circuit reversed the Board. (R. 20.)

The two oil leases referred to above are set out

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

7

SALON! Lt PRAT OY AE

—

SUMMARY OF ARGUMENT

1. The question presented is whether a sale of

capital assets was consummated. Congress did not

qualify the word ‘‘sale,’’ and, hence, it was used

in its ordinary sense. (U.S. v. Merriam, 263 U.

8.179.) If the instruments given by the respond-

ent passed title to the oil and gas in place to the

lessee, a sale was consummated, as this is the es-

sence of a sale. (23 R. C. L. 1186; 55 C. J. 36.)

2. It is the settled law of the State of Texas that

such instruments convey title to the oil and gas in

place to the lessee, which is a sale as contemplated

by the Act. (Group No. 1 Oil Corp. v. Bass, 283

U. S. 279; Thetsin v. Robison, 117 Tex. 489, 502

S. W. (2d) 646; Texas Co. v. Daugherty, 107 Tex.

226, 176 S. W. 717; Stephens Co. v. Mid-Kansas

Ol & Gas Co., 113 Tex. 160, 154 S. W. 290, ef. W.

T. Waggoner Est. v. Wichita Co., 273 U. 8. 113.)

Hence a sale was consummated by the taxpayer on

the execution and delivery of the instruments in

question.

3. The federal courts will follow state laws with

respect to the title to property. (25 C. J. 839; 27

R.C. L. 51; 28 U. S.C. A., annotation 143; Guffey

v. Smith, 237 U. S. 112, 113; Poe v. Seaborn, 282

U.S. 101; U. S. v. Robbins, 269 U. S. 315; U.S. v.

Malcolm, 282 U. 8. 792; Crooks v. Farelson, 282

U. S. 55; U. S. v. Cambridge Loan & Bldg. Co.,

278 U.S. 55.)

Work v. Mosier, 261 U. S. 232, chiefly relied

upon by petitioner to sustain his argument that

bonuses received for the execution of oil and gas

leases represent ordinary royalties, is not in point.

8

seat ll

The construction of the Act of June 28, 1906, per-

taining to Osage Indian lands, and not a Revenue

Act, was involved. The question was whether un-

anticipated bonuses received on the execution of

oil and gas leases on these Indian lands should be

paid over to the Indians quarterly as “‘royalties,”’

or kept on deposit in the Treasury of the United

States with other Indian monies for a number of

years, and only the interest thereon paid over to

the Indians. This Court held that it was a matter

of statutory construction; and that plain intend-

ment of the Act was that such bonuses were to be

paid over quarterly as ‘‘royalties.”’ ;

Cases arising under the Excise Tax Act of 1909

do not help. (U.S.v. Biwabik Min. Co., 147 U.S.

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

8. 503; Strattons’ Ind. v. Howbert, 231 U. S. 399.)

They involved the construction of that particular

Act, which was an excise tax and not an income

tax act.

Stanton v. Baltic Min. Co., 240 U. S. 103, 114,

involved the constitutionality of the Revenue Act

of 1913, and is not pertinent here.

The question at issue is governed by the decisions

of this Court in Group No. 1 Oil Corp. v. Bass,

supra, and Burnet v. Coronado Oil & Gas Co., 285

U.S. 393. Every case, except one, relied upon by

the petitioner, involving the question of whether

bonuses from oil and gas leases represent proceeds

from the sale of capital assets or ordinary royal-

ties, arose in states where it is the settled law that

such leases do not pass title to the oil and gas in

place to the lessee. The exception is Hirschi v.

9

di a ORO RINT POPE EEO wer Sat . omy ATER ST Ree ah a a ide a

a,

U. S., 67 Ct. Cl. 637, and the opinion in that case

was written before this Court decided Group No.

1 Oil Corp. v. Bass, supra, and Burnet v. Coronado

Oil & Gas Co.

The cash consideration was reveived by the re-

spondent from the sale of capital assets, and the

judgment of the Court below should be affirmed.

ARGUMENT

I

TRE CaSH CONSIDERATION RECEIVED BY THE ReE-

SPONDENT Was Nort A ROYALTY

The petitioner argues that the cash considera-

tion received by the respondent on the execution

of the oil and gas leases in question represented

advance royalties, relying chiefly on Work v.

Mosier, 261 U. 8. 232. (Petitioner’s brief, p. 6

et seq.) This suit arose under the Act of June 28,

1906, and Chief Justice Taft stated the subject

matter of the controversy in considerable detail,

which we have summarized as follows:

The Act of June 28, 1906, provided for the en-

rollment of the Osage Indian tribe in Oklahoma

Territory, including minors, for the division of the

land between them by selection, the selection for

the minors being made by their parents, but for-

bade the sale of the oil, gas, coal or other minerals

underlying the lands, such minerals being reserved

to the use of the tribe for a period of twenty-five

years, the royalties to be paid to the tribe. The

Act directed that the oil, gas, coal and other min-

erals should become the property of the individual

10

Ls SE ED LE EN LOSS LITT PAE IONE LEG T ITS SB EERE ES LAO IR I SAR a CORE TH oS

—_—— PARI ARAN RHE SR TION et

owner of the land at the end of that period. Sec-

tion (3) of the Act directed the leasing of the oil,

gas and other mineral rights in the lands by the

tribal counsel under rules and regulations of the

Secretary of the Interior, the royalties to be paid

to the Osage Tribe as determined by the President

of the United States. The effect of the Act was

to give each member of the tribe three selections

of land, all to be farmed by him for twenty-five

years and to become his absolute property at the

end of that time. Under Section (4), funds be-

longing to the tribe from various other sources

were to be held by the United States as trustee for

twenty-five years, and the interest as earned

thereon as to be divided among the members of

the tribe. In addition, under the second paragraph

of Section (4), the royalties received from oil, gas,

coal, and other mineral leases, and certain other

monies, were to be distributed to the members of

the tribe as income, payable quarterly. As the

mineral properties became more valuable, the prac-

tice was initiated of putting up at auction the

privilege of leasing particular mineral properties

of the tribe. Large sums as down payments or

bonuses in addition to the royalties as fixed by the

President were realized for the benefit of the tribe.

The Secretary of the Interior held that these bo-

nuses were not royalties subject to be paid quar-

terly to the tribe as income; but that they were a

part of the trust funds to be held in the Treasury

of the United States until the end of the twenty-

five year period, and that only the interest thereon

should be distributed to the members of the tribe.

11

Pe RLY SRT ML TRL DIORA

The question presented to the Court was not

whether the bonuses represented capital or income

within the meaning of a Revenue Act. The issue

was whether it was the intendment of the Act of

June 28, 1906, that the unexpected down payments

or bonuses should be withheld from the Indians

until the end of the twenty-five year period, or

whether they should be included in ‘‘royalties’’ as

used in the Act and distributed to the members of

the tribe quarterly. That the Court decided the

question solely from the construction of the Act

itself, is clearly indicated by the following lan-

guage of the Chief Justice, beginning at the hot-

tom of page 359:

‘*The question whether bonuses were to be

included in royalties is a matter of statutory

construction, not finally intrusted to the dis-

cretion of the Secretary, but determinable in

Court, at the instance of the beneficiaries, as

of right.’’

The petitioner argues that Work v. Mosier,

supra, has been recognized uniformly where the

distinction between bonus and royalty was sought

to be made, citing Alexander v. King, 46 F. (2d)

235; Ferguson v. Commissioner, 59 F. (2d) 891;

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

326. (Petitioner’s brief, p. 10.)

In Alexander v. King, supra, the oil and gas

leases were made on lands situated in Oklahoma,

where the law of the state is that an oil and gas

lease does not pass title to the oil and gas in place

to the lessee. (Rich v. Dougherty, 71 Okla. 204, 177

Pac. 86, 89.) In deciding Alexander v. King,

12

ee aoe ee eee Re ho a ag qwrt SNP a Se ah? *

eS

supra, the Circuit Court of Appeals not only held

that it was necessary to look to the Oklahoma law

to see whether title to the oil and gas had passed

to the lessee, but clearly distinguished its decision

from Ferguson v. Commissioner, 45 F. (2d) 573,

which involved oil and gas leases of Texas lands, by

pointing out the difference between the laws of

Oklahoma and Texas on this question,

In Ferguson v. Commissioner, 59 F. (2d) 891,

oil and gas leases of Kansas lands were involved,

where the law of the state is that such leases do not

convey title to the oil and gas in place to the lessee.

(Hoover v. McNeill, 102 Kan. 492, 175 Pace. 150;

Finch v. Beyer, 94 Kan, 525, 146 Pac. 1141.) Again

the Cireuit Court of Appeals for the Tenth Cireuit

emphasized the fact that title did not pass. We

quote from the opinion on page 892 as follows:

‘Such leases did not convey title to the oil

and gas in place. They only gave the lessee

the right to go upon the land and to prospect

for, develop, and remove oil and gss there-

from. Under them the respective lessees

would acquire title only to the oil and gas

which they extracted and reduced to posses-

sion.”’

In Appeal of Nelson Land & Oil Company, 3

B. T. A. 315, a West Virginia oil and gas lease was

involved. Under the law of that state, such a lease

does not convey title to the oil and gas in place.

(Toothman v. Courtney, 62 W. Va. 167, 58 8. E.

915; Smith v. Root, 66 W. Va. 633, 66 S. E. 1005.)

To sustain his argument that a bonus represents

advance royalties, the petitioner cites the follow-

13

—_—_ PRE TIN oe et ROP NL PENT” &

ing cases (Petitioner’s brief, p. 10) which do not

refer to Work v. Mosier, supra:

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

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

Hirschi v. United States, 67 Ct. Cl. 637.

In Burkett v. Commissioner, supra, and Berg v.

Commissioner, supra, oil and gas leases of Ar-

kansas lands were involved. The law of that state

is that such instruments do not pass title to the oil

and gas in place to the lessee. (Osborn v. Ark. Ter.

Oil & Gas Co., 103 Ark. 175.)

All of the foregoing cases cited by the petitioner,

with the exception of Hirschi v. United States,

have reference to oil and gas leases in states where

such leases do not convey title of the oil and gas in

place to the lessee. The decisions iii those cases.

therefore, are not inconsistent with the decision of

the court below in the instant case, or with the de-

cision in Ferguson v. Commissioner, 45 F. (2d)

573. The latter two cases and that of Hirschi v.

United States, supra, pertain to Texas leases. It

is our contention that the Hirschi case was er-

roneously decided, as we shall point out later.

The petitioner criticises the distinction which

the Circuit Court of Appeals for the Fifth Circuit

made between the bonus and the one-eighth royalty

interest in deciding Ferguson v. Commissioner, 45

F. (2d) 573. (Petitioner’s brief, p.7.) In view of

the decision of the Court in Group No. 1 Oil Corpo-

ration v. Bass, 283 U.S. 279, and Theisen v. Robin-

son, 117 Tex. 489, 508, 8 S. W. (2d) 646, quoted in

this Court’s opinion to the effect that an oil and

14

S_

gas lease in Texas, with one-eighth royalty re-

served, conveys title to all and not only to seven-

eighths of the oil and gas in place to the lessee, it

may be possible that the Circuit Court of Appeals

for the Fifth Circuit erred in Ferguson v. Commis-

sioner, 45 F’. (2d) 573, in holding that title to only

seven-eighths of the oil and gas passed io the lessee.

However that may be, we are concerned in the

instant case only with the issue of whether the cash

consideration or bonus was received from the sale

of capital assets. Whether it was received for the

sale of seven-eighths or of the entire interest of the

respondent in the oil and gas in place is immate-

rial,

The petitioner in support of his contention that

bonuses represent advance royalties, cites a num-

ber of other cases which are clearly distinguishable

from the case at bar. In United States v. Biwabik

Mining Company, 247 U. 8S. 116 (Petitioner’s

brief, pp. 10, 13), it was held that the proceeds

of iron ore mined by a corporate lessee of

Minnesota lands were income under the Ex-

cise Tax Act of 1909; and that the lessee could

not deduct as capital invested, the fair market

value of the ore in place as of January 1, 1909.

This Court pointed out that under Minnesota law,

a lessee was not a purchaser of the ore in place, and

that this fact was also referred to in Von Bawm-

bach v. Sargent Land Company, 242 U. 8. 503. In

the latter case it was held that royalties received

by a corporate lessor of Minnesota lands repre-

sented income under the Excise Tax Act of 190°

and not the conversion of investment from ore int

15

a PMA ' «he Be EAE YET FY CD ONY, NOON

—

money, following Strattons’ Independence v. How-

bert, 231 U. S. 399. In the last mentioned ease this

Court held that mining corporations extracting

ores from their own premises, were subject to the

Excise Tax Act of 1909; that the proceeds from the

sale of such ores were income under said Act; and

that the difference between the selling price of the

ores and the cost of removing the same, was not

deductible as depreciation under said Act. If the

contention of the taxpayer had been sustained, the

effect would have been that there was no income to

tax, and this would have frustrated the plain in-

tendment of the Act. (Petitioner’s brief, pp. 12,

13, 20.)

In Stanton v. Baltic Mining Company, 240 U. S.

103, 114, this Court rejected the taxpayer’s conten-

tion that the Revenue Act of 1913 was unconstitu-

tional as an unapportioned direct tax when applied

te mining corporations, because the five per cent

(5%) allowance for depletion was inadequate.

(Petitioner’s brief, pp. 12, 13.)

The petitioner further argues that his contention

that a bonus is an advance royalty is supported by

decisions to the effect that lessees may not deduct

the entire bonuses as a business expense in the year

in which paid, but must amortize the deduction

over the life of the lease. (Petitioner’s brief, p.

11.) It is respectfully submitted that these decis-

ions: do not sustain petitioner’s argument, as such

bonuses would be deductible ratably over the term

of the lease irrespective of whether they were

deemed to be advance royalties or considerations

for the purchase of the lease.

16

ENEMA AP it SRN ERNIE ETRE AE, LUGE IONE NY AY PO APRON MAS ARES ae

In view of the foregoing, it is respectfully sub-

mitted that the petitioner’s contention that the

cash consideration received by the respondent on

the execution of the oil and gas leases in question

represented royalties, is unsupported by the cases

referred to in his brief, except Hirschi v. United

States, which will be discussed below.

II

THE CASH CONSIDERATION Was RECEIVED BY THE

RESPONDENT FROM THE SALE OF OIL AND GAS IN

PLACE TO THE LESSEE

The statute provides—

“‘The term ‘capital gain’ means taxable gain

from the sale or exchange of capital assets con-

summated after December 31, 1921.”’ (Italics

ours. )

It is our contention that through the instrumen-

tality of the leases in question, the respondent sold

the oil and gas in place to the lessee.

Congress did not qualify the word “‘sale’”’ in the

statute, and, hence, it was used in its ordinary

judicial sense. (U.S. v. Merriam, 263 U. 8. 179:

Kepner v. U. S., 195 U. 8. 100, 124; The Abbots-

ford v. Johnson, 98 U.S. 440.)

By sale is meant the transfer of title from one

to another. (23 R. C. L. 1186; 55 C. J. 36; Words

& Phrases, First Ser., Vol. 7, p. 6291; Second Ser.,

Vol. 4, p. 436; Third Ser., Vol. 6, p. 907.)

In Five Per Cent Cases, 110 U. 8. 471, 478, the

word “‘sale’’ was defined as follows:

17

OAM! OT ART ERICA, ORS UCN EIR OEM

——y

‘*A sale, in the ordinary sense of the word,

is a transfer of property for a fixed price in

money or its equivalent.”’

We also quote from Williamson v. Berry, 8

How. 495, 544:

‘*Sale is a word of precise legal import, both

at law and in equity. It means at all times, a

contract between parties, to give and to pass

rights of property for money—which the

buyer pays or promises to pay to the seller for

the thing bought and sold.”’

The sole question presented in the case at bar is

whether the respondent sold the oil and gas in place

to the lessee. This is to be determined by Texas

law, as federal courts will follow state law with re-

spect to the title to property. (25 C. J. 839; 27

R. C. L. 51; 28 U. S.C. A., annotation 143; Guffey

v. Smith, 237 U. S. 112, 113; Poe v. Seaborn, 282

U. 8S. 101; U. S. v. Robbins, 269 U.S. 315; U. S. v.

Malcolm, 282 U. 8. 792; Crooks v. Harrelson, 282

U. 8.55; U. S. v. Cambridge Loan & Bldg. Co., 278

U.S. 55.)

It is the settled law of Texas that instruments

commonly known as oil and gas leases convey title

to the oil and gas in place to the lessee. (Theisin

v. Robison, 117 Tex. 489, 502, 8 S. W. (2d) 646;

Texas Co. v. Daugherty, 107 Tex. 226, 176 S. W.

717; Stephens Co. v. Mid-Kansas Oil & Gas Co.,

113 Tex. 160, 254 S. W. 290, cf. W. T. Waggoner

Est. v. Wichita Co., 273 U. S. 113.)

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

the question presented was whether the income of

18

SN oy cea ar oad tec Se ee ga

—ras

a lessee, derived from an oil and gas lease of state

university lands granted by the State of Texas,

was taxable by the federal government. The lessee

contended that the lease was an instrumentality of

the state, and that the income being derived there-

from was exempt from federal income taxation.

This court rejected that contention on the theory

that the lessee acquired title to the oil and gas in

place on the execution of the lease, and that the in-

come was derived from the sale of its own property.

We quote briefly from the opinion written by Mr.

Justice Stone, as follows:

“Section 12 of Article 7 of the state Consti-

tution, as interpreted by the highest court of

the state, ‘requires the legislature to dispose of

the university lands by sale only.’ Theisen v.

Robison, 117 Tex. 489, 502, 8S. W. (2d) 646.

Leases of university lands like those of peti-

tioner have been held by that court to be in

compliance with this provision of the Consti-

tution as present sales to the lessees, upon ex-

ecution of the leases, of the oil and gas in place.

Theisen v. Robison, supra. In so construing

them, the court applied the settled rule of the

state with respect to oil and gas leases. Texas

Co. v. Daugherty, 107 Tex. 226, L. R. A. 1917F,

989, 176 S. W. 717; Stephens County v. Mid-

Kansas Oil & Gas Co., 113 Tex. 160, 29 A. L. R.

966, 254 S. W. 290, cf. W. T. Waggoner Estate

v. Wichita County, 273 U. 8. 113, 71 L. ed. 566,

47 S. Ct. 271. As was said in Theisen v. Robi-

son, supra, (117 Tex. 510, 511, 8 S. W. (2d)

646) :

" ‘They (the leases) do not authorize the

purchaser to take and use seven-eighths or any

19

other mere fractional part of the oil or gas in

the land leased. The purchaser instead buys

all the oil and gas, for a stipulated price, part

of the price being measured by the value of a

certain fraction of the produced oil and gas,

which is a very different thing from the value

of that fraction of the oil and gas in place. The

leases convey all the oil and gas in granting the

right .» find, produce, and appropriate all of

them, in consideration of the payment of stip-

ulated sums and also the value of a stated frac-

tion of the oil and gas produced’.”’

The leases in Group No. 1 Oil Corp. v. Bass,

supra, and those in the instant case are in all mate-

rial respects the same. In terms they ‘‘grant’’ and

‘“‘lease’’ for a period of years, with renewal privi-

leges, the right to enter on the designated lands for

the purpose of “‘drilling and operating,’ in the

Group No. 1 Oil case, and ‘‘mining and operat-

ing,’’ in the instant case, and to erect and maintain

all necessary structures for the production, trans-

portation and storage of the oil and gas. The les-

see in Group No. 1 Oil Corporation case, was re-

quired to pay the lessor the value of one-eighth of

the petroleum produced and one-tenth of the gas

sold; and in the instant case the lessee was required

to pay the lessor the equal of one-eighth part of

the oil produced and one-eighth of the value at the

wells of the gas, and in addition a cash consider-

ation or bonus. (283 U.S. 281; R. 15.)

In Burnet v. Coronado Oil & Gas Co., 283 U. S.

393, a similar question arose with respect to the

income of a lessee, derived from an oil and gas

lease from the State of Oklahoma. It was held

that the income was exempt, inasmuch as title did

not pass to the lessee on the execution of the lease.

We quote from that part of the opinion written

by Mr. Justice McReynolds, wherein he refers to

the decision of the Court in the earlier case of

Group No. 1 Oil Corp. v. Bass, supra.

‘And as there distinctly indicated, the ex-

emption claimed by the oil corporation was de-

nied because under the settled rule applied by

the Texas Supreme Court, the oil and gas from

disposal of which the corporate income arose

had been purchased, not obtained under a

lease-title had passed out of the state by a

present sale. Status of title was matter for

determination under laws of the state as con-

strued and applied by her courts. In the pres-

ent cause there is no basis for saying that ac-

cording to the local law, the transactions be-

tween the State and the lessee amounted to a

sale. The distinction between cases involving

sales and those where leases had been made

seemed sufficiently apparent when Group No.

1 Ou Corp. v. Bass, was decided, and is not

less obvious now.’’ (Italics ours.)

The foregoing decisions of this Court definitely

settled the proposition that under Texas’ law, the

instruments in question were deeds, conveying title

of the oil and gas in place from the respondent to

the grantee, notwithstanding they customarily were

designated as leases.

The petitioner, however, attempts to distinguish

Group No. 1 Oil Corp. v. Bass, supra, from the

one at bar (Petitioner’s brief, pp. 26, 27, 28), by

arguing that under the Texas Constitution, the

21

PE PERERA LA CDOS NSO OIE

—

only way the state could dispose of its public lands

was by means of a sale; that it became necessary to

determine what was the actual fact as to the own-

ership of the property which produced the income;

that there is no question presented here of deter-

mining the relation between the state and a lessee;

that the instant case is concerned with a lease made

between private parties; that the question is not

whether a federal tax imposes an unconstitutional

burden upon the state; but merely whether the in-

come produced by the lease is to be put in one class

or another; and that Congress has power to make

a classification satisfactory to itself without regard

to state law.

It is submitted that the petitioner’s attempt to

distinguish the Group No. 1 Oil Corp. v. Bass case

from the instant one completely fails.

In the Group No. 1 Oil Corp. case, it was neces-

sary to determine whether title had passed from

the state ; so, also, in the instant case is it necessary

to decide whether title has passed from the re-

spondent in order to ascertain whether a sale was

made by him. In the former case, it was necessary

to determine the relationship between the state and

the lessee; and this is true here in order to ascer-

tain whether a sale was made by the respondent.

The next proposition made by the petitioner,

that the question is whether the income produced

by the leases is to be put in one class or another,

cannot be conceded. The cash payment in ques-

tion represents the consideration for the transfer

of the oil and gas in place to the lessee. This pay-

ment was not dependent upon the operation of the

leases, or whether they ever produced any income

after the transfers were made. The sole question

presented to this Court is whether a sale was made

by the respondent.

It is conceded that Congress has the power to

make a classification satisfactory to itself without

regard to State law; but Congress did not do so

here. The terms ‘‘capital gain,’ ‘capital assets, ’’

and ‘‘ordinary net income” are defined in the

statute. Congress thereby indicated that they were

to be construed as defined, without regard to the

ordinary meaning. The term “sale,” however, was

not defined; and it must be presumed that it’ was

used in its ordinary sense, i. e., a transfer of title

to property.

The petitioner argues that:

‘Tf the income from an oil and gas lease is

to be classified as capital gain when the trans-

action takes place in Texas but as ordinary in-

come when the transaction occurs in any other

state, it is at once apparent that Texas tax-

payers will be favored in a way not contem-

plated by Congress. It is reasonable to sup-

pose that Congress intended the statute to be

uniformly applied, since the desirability of

the uniform application of Federal statutes is

generally recognized.’’ (Petitioner’s brief, p.

23.)

This same argument might have been made with

greater force in connection with the questions pre-

sented in the community property cases (Poe v.

Seaborn, supra), in the building and loan cases

(Cambridge L. & Bldg. Co., supra), and in the

estate tax case of Crooks v. Harrelson, supra; but

this Court held that the law of the state controlled.

The principle that federal courts will recognize

state laws with respect to the title to property is

very emphatically demonstrated by the decisions

of this Court in U. S. v. Robbins, 269 U. S. 315,

and U.S. v. Malcolm, 282 U. 8. 792. The question

in each case was whether the community income

in California was divisible between husband and

wife for income tax purposes. In the first case,

it was held that it was not divisible, because under

California law the wife had a mere expectancy, as

contra-distinguished from a vested interest, in

one-half of the community property. Subsequent

to the Robbins decision, the California law was

changed, giving a wife vested interest in one-half

of the community property; and it was held in

the Malcolm case that one-half of the community

income was returnable each by husband and wife.

The community property decisions turned on the

question of whether the wife owned the income,

and it was held that the question was determined

by state law. In the instant case, it is necessary

to determine who owns the oil and gas in place

in order to ascertain whether a sale was made,

and this necessarily depends upon Texas law.

Other cases are cited by petitioner to support

his contention that Texas law does not control in

the instant case; but we submit that they are not

pertinent to the issue.

In U. S. v. Cambridge L. & Bldg. Co., (Peti-

tioner’s brief, p. 25), it was held that Congress

did not define the term ‘‘building and loan asso-

_ <<

a SE A YS IY i APR

ciation,”’ and, consequently, that it was necessary

to look to the state law. This case did not turn on

any requirement of the statute to follow state law,

but merely on the proposition that Congress did

not define the term. Clearly it does not support

petitioner’s contentions that Texas law should be

disregarded in the instant ease.

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

the lessor of Pennsylvania lands gave a lease long

prior to March 1, 1913, reserving monthly rentals.

The Court recognized that under the Pennsylvania

law the lease conveyed title to the coal in place

to the lessee, and held that a part of the payment

represented capital and a part income; but inas-

much as the taxpayer merely contended that the

entire payments were capital and not income, the

findings of the Commissioner of Internal Revenue

were not disturbed.

In Pocahontas Coal Co. v. Commissioner, 55 F.

(2d) 626, (Petitioner’s brief, pp. 20, 22), coal

leases of West Virginia lands made prior to March

1, 1913, were involved. The Court recognized that

under the West Virginia law such leases conveyed

title to the coal in place to the lessee, but rejected

the taxpayer’s contention that the entire royalties

received from 1920 to 1926 represented capital.

No alternative contention was made that the pres-

ent worth of the royalties on March 1, 1913, repre-

sented capital, but merely that the depletion

allowance was inadequate. These two last men-

tioned cases might be applicable to the instant

case, if the taxpayer had made the leases in ques-

tion prior to March 1, 1913, with cash consider-

25

ation deferred until 1924, and then contended that

the entire cash consideration was capital in the

year in which received.

In Burk Waggoner Oil Assn. v. Hopkins, 269

U. S. 110, (Petitioner’s brief, p. 30), in addition

to the issue of constitutionality, the question was

whether the Burk Waggoner Oil Assn., an unin-

corporated joint stock association conducting its

business as a corporation, should be taxed as a

corporaticn or as a partnership, the taxpayer con-

tending that it was taxable as the latter under the

Revenue Act of 1918, inasmuch as under the com-

mon law of Texas, it was recognized as a partner-

ship.

In the opinion, this Court called attention to

the fact that the Act imposed the tax on partner-

ships and on corporations; that Congress defined

the term ‘‘corporation”’’ to include associations;

and that Congress evidenced an intent to tax such

associations as corporations, where they conducted

their business as corporations, irrespective of

whether such associations were known as partner-

ships under state law.

If the Act had not included associations in the

definition of ‘‘corporation,’’ doubtless the Court

would have held that the association was taxable

as a partnership; but inasmuch as Congress de-

fined ‘‘corporations,’’ to include associations, it

was held that it was the intendment of the Act

to tax such associations as corporations instead of

ordinary partnerships.

In Weiss v. Weiner, 279 U. S. 333, the question

was whether a lessee of a long term lease acquired

—

after March 1, 1913, could take a deduction for

depreciation of buildings, where he did not pay

anything for the lease except an annual rental and

did not pay for the buildings on the leased prem-

ises. This Court held that he could not, and that

it was immaterial that under the Ohio law, where

the properties were located, such a lease was

treated in many respects as a conveyance of the

fee. There was no capital invested or March 1,

1913, value involved, and, hence, no allowable de-

duction. (Petitioner’s brief, pp. 20, 21.)

In view of the foregoing, it is respectfully sub-

mitted that the cash consideration was received

by the respondent for the sale of his oil and gas

in place to the lessee and not as advance royalty

for the lease of the minerals.

ITT.

THE CasH CONSIDERATION Is TAXABLE

As CaprtaL GAIN

The record discloses that the respondent owned

the fee simple title to the lands in question for

more than two years prior to sale. (R.8.) Sinee

the cash payment received by the respondent on

the execution of the leases in question represented

consideration for the sale of the oil and gas in

place to the lessee and not ordinary royalties, as

contended by the petitioner, such income is tax-

able as capital gain and not as ordinary income.

The petitioner says, however, that at the time

the capital gain provisions first appeared in the

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

law was settled that mining leases did not con-

—— ns anailintintamnaniniesiienes

vey title to ore in place, citing Lynch v. Alworth-

Stephens Co., 267 U. S. 364, 371, and Ewert v.

Robinson, 289 F. (2d) 740, 747, and that Congress

is presumed to have legislated with this in mind.

(Petitioner’s brief, p. 14.)

In Lynch v. Alworth-Stephens Co., supra, Min-

nesota leases were involved, and it was held that

under the law of Minnesota, such leases did not

convey title to the ore in place to the lessee, citing

U.S. v. Biwabtk Min. Co., supra, and Von Baum-

bach v. Sargent Land Co., supra.

In Ewert v. Robinson, supra, the action was one

of ejectment. The plaintiff claimed that the in-

strument in question was a lease for years and

the defendant contended that it was a mere license

or option. The lands were situated in Oklahoma.

In passing on the question, the Circuit Court of

Appeals for the Eighth Cireuit cited a number

of decisions of the Supreme Court of Oklahoma

to the effect that title to the oil and gas did not

pass to the lessee, and also the decisions of this

Court referred to above, where Minnesota leases

were under consideration.

We do not concede that at the time the first

capital gain provision was incorporated into a

Revenue Act, it was settled law that mining leases

did not convey title to ore in place. It was estab-

lished law at that time, however, that mining leases

did not convey title to the mineral in place to the

lessee, contrary to the settled law of the state. In

using the term ‘‘sale,’’ without statutory defini-

tion, the more logical presumption is that Congress

legislated with the well established principle in

mind, that whether a sale of property is made is

— CU

dependent upon the law of the state where the

transaction is consummated. Any other rule

would work incalculable hardships and produce

incongruous results. In the instant case, for in-

stance, if petitioner’s contention should prevail,

for federal income tax purposes the tax would be

levied on the theory that the lessee did not acquire

title to the oil and gas in place, whereas in Texas,

state and local taxes would be levied on the theory

and in accordance with the actual fact that the

lessee owned the oil and gas in place. Clearly,

there is nothing in the Revenue Act of 1924 which

requires a holding that the respondent still owns

the oil and gas in place, when in fact and in law

he does not.

The petitioner further argues that the avowed

purpose of the capital gain provisions supports

the construction for which he contends (Petition-

er’s brief, pp. 16-19) ; but we submit that the legis-

lative history of the capital gains provisions sup-

ports the contention of the respondent.

The purpose of these provisions as expressed in

the House and Senate reports accompanying the

Revenue Act of 1921, was to encourage the “sale

of farms, mineral properties, and other capital as-

sets,’’ and to increase revenue. (Italics ours.)

(H. Rept. No. 350, p. 10, quoted in respondent’s

brief, pp. 29, 30; S. R. No. 275, p. 12.) The term

‘capital assets” according to the statutory defini-

tion “‘means property held by the taxpayer for

more than two years * * *’’; and the Courts

have held repeatedly that the term properly in-

cludes oil and gas in place. (22 R. C. L. 58; 40

C. J. 903; 50 C. J. 749; Stephens v. Stephens, (Ct.

29

—— IE? LORIE ESR LEI IET NIL STII

a.

Civ. A. Texas) 292 S. W. 290; Stephens Co. v.

Mid-Kansas Oil & Gas Co., 113 Tex. 160, 254 S. W.

290.) Clearly the petitioner can derive no comfort

from legislative history of the Act.

The petitioner seeks to limit she application of

the term “‘sale of capital assets’’ to a transfer of

property in which the owner parts with his entire

interest for a consideration, and to exclude its ap-

plication from a situation in which the owner

retains an interest in the land. The statute refers

to the ‘‘sale or exchange of capital assets,’’ with-

out any restriction that it shall apply to a sale or

disposition of the entire interest of the owner, and

that it shall not apply where the owner retains an

interest in the land. We submit that there is no

logical basis for such a narrow’ construction of the

Act, especially where the avowed purpose of it was

to encourage sales of ‘‘farms, mineral properties

and other capital assets,’’ and to increase revenue.

With reference to petitioner’s contention that

the respondent ‘‘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’’; (Petitioner’s brief

p. 18) it is sufficient to reply that it is contrary to

sound rules of logic to assume as a premise the

identical proposition which is attempted to be

proved. ta

A careful study of the cases cited by the peti-

tioner discloses that Hirschi v. U. S., 67 Ct. Cl.

637, is the only one in conflict with the decisions

of the Circuit Court of Appeals for the Fifth Cir-

cuit in Ferguson v. Commissioner, 45 F.. (2d) 573,

and the instant case. The facts and the issue in

30

the Hirschi case and the instant ore are the same.

In the former the Revenue Act of 1921, and in the

latter the Revenue Act of 1924 is involved; but

these Acts are materially the same.

The Court of Claims held that in accordance

with the weight of authority and the decisions of

this Court, an oil and gas lease did not convey title

to the oil and gas in place, and further that Con-

gress was not limited in the selection of subjects

for taxation by the construction of state Courts as

to the property rights of individuals.

The Hirschi case was decided before this Court

decided Group No. 1 Oil Corp. v. Bass, supra, and

Burnett v. Coronado Oil & Gas Co., supra; and it

is reasonable to assume that that Court would

reach a different conclusion if the question were to

be presented again.

We take no exception to the Court of Claims’

statement that Congress was not limited in the

selection of subjects for taxation by the construc-

tion of state Courts as to the property rights of

individuals; but we submit that that question was

not an issue in the Hirschi case or in the one at

bar. The matter is one solely of construction and

not of power.

We respectfully submit that the judgment of the

Court below should be affirmed.

Respectfully submitted,

Watrter E. Barton,

Investment Building,

Washington, D. C.

Counsel for W. T. Waggoner and

Ella Waggoner, as Amicus Curiae.

31