Anderson v. Helvering Prichard v. Same

• Decision Date: 20 May 1940
• Docket Number: Nos. 682,683,s. 682
• Citation: 84 L.Ed. 1277,60 S.Ct. 952,310 U.S. 404
• Parties: ANDERSON v. HELVERING, Commissioner of Internal Revenue. PRICHARD v. SAME
• Court: U.S. Supreme Court

310 U.S. 404

60 S.Ct. 952

84 L.Ed. 1277

ANDERSON

v HELVERING, Commissioner of Internal Revenue.

PRICHARD

v. SAME.

Nos. 682, 683.

Argued April 2, 1940.

Decided May 20, 1940.

Mr. Charles H. Garnett, of Oklahoma City, for petitioners.

Mr. J. Louis Monarch, Sp. Asst. to Atty. Gen., for respondent.

Mr. Justice MURPHY delivered the opinion of the Court.

Oklahoma City Company in 1931 owned certain royalty interests, fee interests, and deferred oil payments in properties in Oklahoma. During that year it entered into a written contract with petitioner Prichard providing for the conveyance to him of these interests for the agreed consideration of one hundred sixty thousand dollars, payable fifty thousand in cash and one hundred ten thousand from one-half of the proceeds received by him which might be derived from oil and gas produced from the properties and from the sale of fee title to any or all of the land conveyed. Interest at the rate of 6% per annum was to be paid from the proceeds of production and of sales upon the unpaid balance. Oklahoma Company was to have in addition a first lien and claim against 'that one half of all oil and gas production and fee interest * * * from which the $110,000 is payable', the lien and claim 'not in any way (to) affect the one-half interest in all oil and gas production and fee interest or the revenue therefrom which * * * (it) is to have and receive under this agreement.' The proceeds derived from the oil and gas produced and from sales of the fee interests were to be paid directly to Prichard who was to deposit one-half of them at a designated bank, at intervals of 90 days, to the credit of Oklahoma Company. The agreement recited that Oklahoma Company desired 'to sell all of its right, title and interest of whatsoever nature' in the described properties, and provided that a copy of the agreement and a release be placed in escrow for delivery to Prichard upon payment in full of the one hundred ten thousand dollars and interest. Immediately upon the execution of the contract the properties were conveyed to Prichard without reservation.¹ In entering into the agreement Prichard acted not only for himself but also for petitioner Anderson, each of them having a 45% interest. ²

The gross proceeds derived from the production and sale of oil from the properties³ during 1932 amounted to some eighty-one thousand dollars. Prichard, upon receiving this sum, distributed one-half to Oklahoma Company pursuant to the contract. The question for decision is whether the proceeds thus paid over to Oklahoma Company should be included in the gross income of petitioner for the tax year 1932.⁴ The ruling of the Board of Tax Appeals against petitioners was affirmed by the Circuit Court of Appeals. 10 Cir., 107 F.2d 459. Because of an asserted conflict with the applicable decisions of this Court, we granted certiorari. 60 S.Ct. 609, 84 L.Ed. —-. March 4, 1940.

It is settled that the same basis issue determines both to whom income derived from the production of oil and gas is taxable and to whom a deduction for depletion is allowable. That issue is, who has a capital investment in the oil and gas in place and what is the extent of his interest. Helvering v. Bankline Oil Co., 303 U.S. 362, 367, 58 S.Ct. 616, 618, 82 L.Ed. 897; Helvering v. O'Donnell, 303 U.S. 370, 58 S.Ct. 619, 82 L.Ed. 903; Helvering v. Elbe Oil Co., 303 U.S. 372, 58 S.Ct. 621, 82 L.Ed. 904; Thomas v. Perkins, 301 U.S. 655, 661, 663, 57 S.Ct. 911, 913, 914, 81 L.Ed. 1324; Helvering v. Twin Bell Oil Syndicate, 293 U.S. 312, 321, 55 S.Ct. 174, 178, 79 L.Ed. 383; Palmer v. Bender, 287 U.S. 551, 53 S.Ct. 225, 77 L.Ed. 489. Compare Helvering v. Clifford, 309 U.S. 331, 60 S.Ct. 554, 84 L.Ed. —-. No. 383, October Term, 1939.

Oil and gas reserves like other minerals in place, are recognized as wasting assets. The production of oil and gas, like the mining of ore, is treated as an incomeproducing operation, not as a conversion of capital investment as upon a sale, and is said to resemble a manufac- turing business carried on by the use of the soil. Burnet v. Harmel, 287 U.S. 103, 106, 107, 53 S.Ct. 74, 75, 77 L.Ed. 199; Bankers' Coal Co. v. Burnet, 287 U.S. 308, 53 S.Ct. 150, 77 L.Ed. 325; United States v. Biwabik Mining Co., 247 U.S. 116, 38 S.Ct. 462, 62 L.Ed. 1017; Von Baumbach v. Sargent Land Co., 242 U.S. 503, 521, 522, 37 S.Ct. 201, 206, 61 L.Ed. 460; Stratton's Independence v. Howbert, 231 U.S. 399, 414, 34 S.Ct. 136, 139, 58 L.Ed. 285. The depletion effected by production is likened to the depreciation of machinery or the using up of raw materials in manufacturing. United States v. Ludey, 274 U.S. 295, 302, 303, 47 S.Ct. 608, 610, 611, 71 L.Ed. 1054; Lynch v. Alworth-Stephens Co., 267 U.S. 364, 370, 45 S.Ct. 274, 275, 69 L.Ed. 660. Compare Von Baumbach v. Sargent Land Co., supra, 242 U.S. at pages 524, 525, 37 S.Ct. 201, 208, 209, 61 L.Ed. 460. The deduction is therefore permitted as an act of grace and is intended as compensation for the capital assets consumed in the production of income through the severance of the minerals. Helvering v. Bankline Oil Co., 303 U.S. 362, 366-367, 58 S.Ct. 616, 617, 618, 82 L.Ed. 897. The granting of an arbitrary deduction, in the interests of convenience, of a percentage of the gross income derived from the severance of oil and gas, merely emphasizes the underlying theory of the allowance as a tax-free return of the capital consumed in the production of gross income through severance. Helvering v. Twin Bell Oil Syndicate, 293 U.S. 312, 321, 55 S.Ct. 174, 178, 79 L.Ed. 383; United States v. Dakota-Montana Oil Co., 288 U.S. 459, 467, 53 S.Ct. 435, 438, 77 L.Ed. 893.

The sole owner and operator of oil properties clearly has a capital investment in the oil in place, if anyone has, and so is taxable on the gross proceeds of production and is granted a deduction from gross income as compensation for the consumption of his capital. See Burnet v. Harmel, supra, 287 U.S. at pages 107, 108, 53 S.Ct. 75, 76, 77 L.Ed. 199; Helvering v. Clifford, 309 U.S. 331, 60 S.Ct. 554, 84 L.Ed. —-, No. 383, October Term, 1939. By an outright sale of his interest for cash, such an owner converts the form of his capital investment, severs his connection with the production of oil and gas and the income derived from production, and thus renders inapplicable to his situation the reasons for the depletion allowance. 'The words 'gross income from the property,' as used in the statute governing the allowance for deple- tion, mean gross income received from the operation of the oil and gas wells by one who has a capital investment therein,—not income from the sale of the oil and gas properties themselves.' Helvering v. Elbe Oil Land Co., 303 U.S. 372, 375, 376, 58 S.Ct. 621, 622, 82 L.Ed. 904.

Other situations, falling between the two mentioned, have been put on one side or the other as the cases arose. The holder of a royalty interest—that is, a right to receive a specified percentage of all oil and gas produced during the term of the lease—is deemed to have 'an economic interest' in the oil in place which is depleted by severance. Palmer v. Bender, 287 U.S. 551, 557, 53 S.Ct. 225, 226, 77 L.Ed. 489; Murphy Oil Co. v. Burnet, 287 U.S. 299, 53 S.Ct. 161, 77 L.Ed. 318; Burnet v. Harmel, 287 U.S. 103, 53 S.Ct. 74, 77 L.Ed. 199. See Lynch v. Alworth-Stephens Co., 267 U.S. 364, 45 S.Ct. 274, 69 L.Ed. 660. Cash bonus payments, when included in a royalty lease, are regarded as advance royalties and are given the same tax consequences. Burnet v. Harmel, 287 U.S. 103, 53 S.Ct. 74, 77 L.Ed. 199; Murphy Oil Co. v. Burnet, 287 U.S. 299, 53 S.Ct. 161, 77 L.Ed. 318; Bankers' Pocahontas Coal Co. v. Burnet, 287 U.S. 308, 53 S.Ct. 150, 77 L.Ed. 325. Compare Helvering v. Elbe Oil Land Co., 303 U.S. 372, 375, 58 S.Ct. 621, 622, 82 L.Ed. 904. A share in the net profits derived from development and operation, on the contrary, does not entitle the holder of such interest to a depletion allowance even though continued production is essential to the realization of such profits. Helvering v. O'Donnell, 303 U.S. 370, 58 S.Ct. 619, 82 L.Ed. 903; Helvering v. Elbe Oil Co., 303 U.S. 372, 58 S.Ct. 621, 82 L.Ed. 904. Similarly, the holder of a favorable contract to purchase wet gas at the mouth of the well is denied a depletion allowance on the difference between the contract price and the fair market value. Helvering v. Bankline Oil Co., 303 U.S. 362, 58 S.Ct. 616, 82 L.Ed. 897. Such an interest has been characterized by us as a 'mere economic advantage derived from production, through a contractual relation to the owner.' Helvering v. Bankline Oil Co., supra, 303 U.S. at page 367, 58 S.Ct. at page 618, 82 L.Ed. 897.

Thomas v. Perkins, 301 U.S. 655, 57 S.Ct. 911, 81 L.Ed. 1324, relied upon by petitioners, presented the issue whether the right to oil pay- ments—that is, the right to a specified sum of money, payable out of a specified percentage of the oil, or the proceeds received from the sale of such oil, if, as and when produced—should be treated for tax purposes like the right to oil royalties or like the right to cash payments upon a sale. In that case, the assignment of lease provided for payments in oil only without the reservation of a royalty interest. The question was whether the assignees' gross income should include moneys paid to the assignors by purchasers of the oil. We stated (301 U.S. page 659, 57 S.Ct. page 912, 81 L.Ed. 1324): 'The granting clause in the assignment would be sufficient, if standing alone, to transfer all the oil to the assignee. It does not specifically except or exclude any part of the oil. But it is qualified by other parts of the instrument. The provisions for payment...