Atlantic Oil Co. v. Los Angeles County

CourtUnited States State Supreme Court (California)
Citation446 P.2d 1006,69 Cal.2d 585,72 Cal.Rptr. 886
Decision Date18 November 1968
Parties, 446 P.2d 1006 ATLANTIC OIL COMPANY et al., Plaintiffs and Appellants, v. COUNTY OF LOS ANGELES et al., Defendants and Appellants. HUMBLE OIL & REFINING COMPANY et al., Plaintiffs and Appellants, v. CITY OF LONG BEACH, Defendant and Appellant. HAMMIL OIL CORPORATION et al., Plaintiffs and Appellants, v. COUNTY OF ORANGE et al., Defendants and Respondents. L.A. 29534, 29535.

Hanna & Morton, Harold C. Morton, John H. Blake and Edward S. Renwick, Los Angeles, for plaintiffs and appellants.

John D. Maharg, County Counsel (Los Angeles), John D. Cahill, Deputy County Counsel, Leonard Putnam, City Atty., Kenneth K. Williams, Deputy City Atty., Hill, Farror & Burrill, Carl A. Stutsman, Jr., Vincent C. Page, Jack R. White, Los Angeles, Keil & Connolly, George A. Connolly, Richard Dole, San Francisco, Adrian Kuyper, County Counsel (Orange), and Robert F. Nuttman, Asst. County Counsel, for defendants and appellants and for defendants and respondents.

Thomas C. Lynch, Atty. Gen., Jay L. Shavelson, Asst. Atty. Gen., and Phillip G. Samovar, Deputy Atty. Gen., amici curiae in L.A. 29534.

TRAYNOR, Chief Justice.

In these consolidated appeals plaintiff taxpayers seek to recover taxes that they claim were based on improper assessments. Both plaintiffs and defendants in L.A. 29534, appeal from a judgment upholding 46 assessments and invalidating three assessments by the County of Los Angeles and the City of Long Beach for the tax year 1963--64. The State Lands Commission of the State of California appears as amicus curiae in support of two of those plaintiffs. In L.A. 29535, plaintiffs appeal from a separate judgment upholding 37 assessments by the County of Orange for the tax year 1964--65.

The facts are not in dispute. By virtue of various documents, plaintiff oil operators obtained from tax-exempt governmental entities rights to drill for and extract oil, gas, and other hydrocarbons from specified public lands, together with necessary surface occupancy and access rights. The documents grant such rights for specified periods and are variously denominated leases, orders, permits, agreements, and drilling and operating contracts. Each provides that the governmental entity owning the property is to receive a percentage or fraction of production payable in cash or in kind.

Plaintiffs' rights in the public lands are admittedly subject to ad valorem property taxes as mining rights or mineral rights. Assessors for defendant cities and counties employ the capitalization of income method of assessing these rights. 1 Before 1963 the County of Los Angeles and the City of Long Beach assessed such rights by estimating the present value of the oil, gas, and other hydrocarbons expected to be recovered over the anticipated duration of each agreement and subtracting therefrom (1) the estimated present value of the anticipated costs of withdrawing those substances and (2) the estimated present value of the sums that each plaintiff would be required to pay the government entity owning the land in money or in kind. The assessed value was derived by multiplying the fair market value by the ratio of assessed values to fair market values prevailing generally throughout the taxing jurisdiction. Before 1964 the Orange County assessor employed a substantially similar method. 2 Each governmental entity then applied the apropriate tax rate to the assessed value to compute the taxes. 3

After 1963 in Los Angeles County and the City of Long Beach, and after 1964 in Orange County, the assessors no longer excluded value attributable to the portion of production to be paid to governmental entities in calculating the fair market value of plaintiffs' interests. This change in assessment procedures resulted in a large increase in the assessed value of plaintiffs' interests and a corresponding increase in their taxes. 4 After exhausting their administrative remedies, plaintiffs filed actions seeking recovery of taxes resulting from the increased assessments and declaratory relief. In L.A. 29534, the superior court entered judgment in favor of plaintiffs with respect to three assessments of mineral rights granted under documents entitled 'drilling and operating contracts,' but otherwise sustained the method of valuation employed by the County of Los Angeles assessor and the City of Long Beach assessor. In L.A. 29535, the superior court sustained the method of valuation employed by the Orange County assessor in all cases, including his assessment of rights under a 'drilling and operating contract' similar to those in L.A. 29534.

Leases, Orders, and Permits

We first consider the instruments, denominated as leases, 5 order, or permits. 6 Each conveys to a lessee the exclusive right to drill for and extract oil, gas, and other hydrocarbons from beneath specified publicly owned land, together with necessary surface occupancy and access rights. Some instruments convey those rights for a fixed term, and others for so long as oil and gas are produced in paying quantities. Each instrument entitles the lessor to a percentage or fraction of production, to be taken either in kind or in cash. 7

The nature of the rights created by such instruments is settled in California. '(T)he owner of land does not have an absolute title to oil and gas in place as corporeal real property, but, rather, the exclusive right on his permises to drill for oil and gas, and to retain as his property all substances brought to the surface on his land.' (Callahan v. Martin (1935) 3 Cal.2d 110, 117, 43 P.2d 788, 792, 101 A.L.R. 871. See also La Laguna Ranch Co. v. Dodge (1941) 18 Cal.2d 132, 135, 114 P.2d 351, 135 A.L.R. 546; Gerhard v. Stephens (1968) 68 A.C. 927, 942--943, 69 Cal.Rptr. 612, 442 P.2d 692.)

Under the instruments herein, each public entity granted the privilege of drilling for and producing oil and gas exclusively to a lessee without reservation or exception for the term of the lease. 'The right (to drill for and produce oil) when granted is a profit A prendre, a right to remove a part of the substance of the land. A profit A prendre is an interest in real property in the nature of an incorporeal hereditament. * * * The profit A prendre, whether it is unlimited as to duration or limited to a term of years, is an estate in real property. If it is for a term of years, it is a chattel real, which is nevertheless an estate in real property, although not real property, or real estate. (Citation omitted.) Where it is unlimited in duration, it is a freehold interest, an estate in fee, and real property or real estate.' (Dabney-Johnston Oil Corp. v. Walden (1935) 4 Cal.2d 637, 649, 52 P.2d 237, 243. See also Callahan v. Martin, supra, 3 Cal.2d 110, 118, 43 P.2d 788; Gerhard v. Stephens, supra, 68 A.C. 927, 942--943, 69 Cal.Rptr. 612, 442 P.2d 692.) Each lessor retained a reversionary interest, the right to drill for and produce oil and gas after the period specified in the lease. (Dabney-Johnston Oil Corp. v. Walden, supra, 4 Cal.2d 637, 647, 52 P.2d 237.) Each lessor also received the right to specified oil and gas royalty payments, a right that we have classified as an incorporeal hereditament, an interest in land. (See Callahan v. Martin, supra, 3 Cal.2d 110, 124, 43 P.2d 788; Standard Oil Co. of California v. John P. Mills Organization (1935) 3 Cal.2d 128, 134, 43 P.2d 797; Dabney-Johnston Oil Corp. v. Walden, supra, 4 Cal.2d 637, 647, 52 P.2d 237.)

It is settled, however, 'that for purposes of taxation the definitions of real property in the revenue and taxation laws of the state control whether they conform to definitions used for other purposes or not.' (Trabue Pittman Corp. v. County of Los Angeles (1946) 29 Cal.2d 385, 393, 175 P.2d 512, 517; see also San Diego Trust & Sav. Bank v. County of San Diego (1940) 16 Cal.2d 142, 147, 105 P.2d 94, 133 A.L.R. 416.) Section 104 of the Revenue and Taxation Code provides that "Real estate' or 'real property' includes: (a) The possession of, claim to, ownership of, or right to the possession of land. (b) All mines, minerals, and quarries in the land, all standing timber whether or not belonging to the owner of the land, and all rights and privileges appertaining thereto. * * * ' 8 Plaintiffs' rights in the public lands are admittedly subject to ad valorem property taxes as 'mining rights' or 'mineral rights' (Rev. & Tax.Code, §§ 201, 104, 607.5), and it is those interests that defendants claim they assessed. Plaintiffs contend, however, that the lessors' interests in land resulting from the rights to royalties are classified as real property by state tax laws, and that such interests are therefore part of the bundle of rights that constitutes the hydrocarbon mineral estate for ad valorem tax purposes. Accordingly, they conclude that failure to deduct the present value of royalty payments in computing the value of their interests results in taxation to them of rights owned by tax exempt lessors.

Although it is calssified under general concepts of property law as an incorporeal hereditament and an interest in land, we conclude that the right to receive royalties is not classified as real property for purposes of taxation. Section 104 of the Revenue and Taxation Code defines real property to include 'all * * * minerals * * * in the land, * * * and all rights and privileges appertaining thereto.' As noted above, in California the right to receive royalties is not a right appertaining to minerals 'in the land.' Rather, it is an interest in oil and gas when they are removed from the land and reduced to possession. The purpose of the qualifying phrase 'in the land' is to differentiate such royalty interests in extratcted minerals from interests in minerals still in the land. 9 Only the latter, which include the right to drill for and extract oil and gas from the land, are real property for tax...

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