# Amicus Curiae Brief — Burnet v. Harmel

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## Record

- **Collection:** Supreme Court brief
- **Document type:** Amicus Curiae Brief
- **Published:** January 1, 1932
- **Citation:** 287 U.S. 103

## Text

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

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40386008_0226%3A07. Public record. Not legal advice.