Alexander v. King

• Citation: 46 F.2d 235,74 ALR 174
• Decision Date: 12 February 1931
• Docket Number: No. 303-306.,303-306.
• Parties: ALEXANDER, Collector of Internal Revenue, v. KING. SAME v. RUZEK.
• Court: United States Courts of Appeals. United States Court of Appeals (10th Circuit)

74 ALR 174, 46 F.2d 235 (1931)

ALEXANDER, Collector of Internal Revenue, v. KING.^*

SAME v. RUZEK.

Nos. 303-306.

Circuit Court of Appeals, Tenth Circuit.

January 2, 1931.

Rehearing Denied February 12, 1931.

T. H. Lewis, Jr., Sp. Atty., Bureau of Internal Revenue, of Washington, D. C. (Roy St. Lewis, U. S. Atty., of Oklahoma City, Okl., and C. M. Charest, Gen. Counsel, Bureau of Internal Revenue, of Washington, D. C., on the brief), for appellant.

Harry O. Glasser, of Enid, Okl., for appellees.

Before COTTERAL, PHILLIPS, and McDERMOTT, Circuit Judges.

McDERMOTT, Circuit Judge.

These four appeals present the same question: The taxpayers own royalty interests under ordinary oil and gas leases; during the taxable years, they received their contract share of the oil produced and have sold it. Are the proceeds of such sales taxable as ordinary income, or are they taxable as capital gains arising from the sales of capital assets held by the taxpayers for more than two years? The trial court held to the latter view, and the collector has appealed.

Helene Walker King filed three suits against the collector, one to recover taxes paid by her for the year 1925, one for the year 1926, and one for the year 1927. She alleged that the taxes so paid arose out of the sale of oil and gas produced from three tracts of land, on which lands and the oil and gas so produced her right was acquired for profit more than two years prior to January 1, 1925; that such oil was not a part of her stock in trade, nor was it held by her primarily for sale in the course of her trade or business; that the oil and gas was produced in the course of development under three leases; the plaintiff and/or her husband owned two of the tracts of land, and she and her husband were the lessors, the plaintiff owning, during the taxable years, one-half of the one-eighth royalty interest therein; the third tract was owned by one Schroeder and/or his wife, and they were the lessors, the plaintiff having acquired, in 1920, one-thirteenth of the lessor's one-eighth interest therein. These leases are, in substance, the same, and grant, let, and lease, for the period of five years or as long thereafter as oil or gas is produced therefrom, the land described "for the sole and only purpose of mining and operating for oil and gas" and purposes incidental thereto. In consideration whereof, the lessee agreed to "deliver to the credit of the lessor, free of cost, in the pipe line to which he may connect his wells, the equal one-eighth part of all oil produced and saved from the leased premises." A cash rental was stipulated for gas used off the premises; there are other covenants unimportant here; the royalty right is without burden or obligation upon plaintiff's part. The plaintiff then alleges that the collector wholly computed her tax in conformity with sections 210 and 211 of the Revenue Acts of 1924 and 1926 (26 USCA § 951 note, 952 note), and denied to her the election of paying the 12½ per cent. of the capital net gain provided by section 208 (26 USCA § 939 note). She filed a claim for refund of the difference in tax, and upon its disallowance brings these suits. Plaintiff's recomputation of the tax is attached to her petition, which discloses that she returned the full sale price of oil sold, and deducted therefrom, not the cost to her, or the March 1, 1913, value, of the capital asset alleged to have been sold, but deducted 27½ per cent. of the sale price as depletion.

A general demurrer to the petition was filed in one of the cases, argued and overruled. Answers by way of general denials were filed, and the cases were submitted on stipulations which the trial court treated as admitting the allegations of the petitions. The stipulations only admit that the taxes were assessed under sections 210 and 211, and that, if they are legally calculable under section 208, there was an overpayment in sums stated. The stipulations do not admit the income arose as alleged. These records are carelessly prepared; the collector filed general denials without admitting the citizenship of plaintiff, his own official capacity, the ownership of the royalty interests, or the sources of the income. The cases were tried on stipulations which cover none of the essential facts except the amount recoverable. But, since the trial court and the parties treat the allegations of the petitions as admitted, and since it is important that the law be determined, we take the petitions as true.

In No. 306, Anna Ruzek had owned the land from which the oil was produced since 1905, and she was the lessor under a lease substantially identical with those above described. She sues to recover taxes paid for the year 1923, and her case is governed by the corresponding sections of the act of 1921. In her case, a demurrer was filed and overruled, an answer was filed, and the same stipulation made as above set out.

Prior to 1921, gain realized from the sale of capital assets was treated as all other income, and subject to the same tax rates. The tax rates were high in the upper surtax brackets, and the gain from such sales often reached into such brackets. Because of such high rates, sales were not made and business was stagnating. Accordingly, the Ways and Means Committee reported out section 206 of the Revenue Act of 1921, 42 Stat. 232 (section 208 in the Revenue Acts of 1924 and 1926 26 USCA § 939 note) to relieve this situation, and in explanation thereof stated:

"The sale of farms, mineral properties, and other capital assets is now seriously retarded by the fact that gains and profits earned over a series of years are under the present law taxed as a lump sum (and the amount of surtax greatly enhanced thereby) in the year in which the profit is realized. Many such sales, with their possible profit taking and consequent increase of the tax revenue, have been blocked by this feature of the present law. In order to permit such transactions to go forward without fear of a prohibitive tax, the proposed bill, in section 206, adds a new section (207) to the income tax, providing that where the net gain derived from the sale or other disposition of capital assets would, under the ordinary procedure, be subjected to an income tax in excess of 15 per cent, the tax upon capital net gain shall be limited to that rate. It is believed that the passage of this provision would materially increase the revenue, not only because it would stimulate profit-taking transactions but because the limitation of 15 per cent is also applied to capital losses. Under present conditions there are likely to be more losses than gains."

Section 208(a), 26 USCA § 939 note, provides that the term "`capital gain' means taxable gain from the sale or exchange of capital assets"; and "the term `capital assets' means property held by the taxpayer for more than two years (whether or not connected with his trade or business), but does not 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."

Section 208(b), 26 USCA § 939 note, provides that — "In the case of any taxpayer (other than a corporation) who for any taxable year derives a capital net gain, there shall (at the election of the taxpayer) be levied, collected, and paid, in lieu of the taxes imposed by sections 951 and 952, 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 951 and 952, and the total tax shall be this amount plus 12½ per centum of the capital net gain."

Section 210 provides for the levy of the normal tax on income, and 211 for the levy of the surtax. Section 214 (26 USCA § 955) authorizes the allowance of certain deductions from income, and included therein is the following:

"In the case of mines, oil and gas wells, other natural deposits, and timber, a reasonable allowance for depletion and for depreciation of improvements, according to the peculiar conditions in each case; such reasonable allowance in all cases to be made under rules and regulations to be prescribed by the commissioner, with the approval of the Secretary. In the case of leases the deduction allowed by this paragraph shall be equitably apportioned between the lessor and lessee."

Section 204(c), 26 USCA § 935, provides that the basis upon which depletion is to be allowed shall be the same as is provided for the purpose of determining gain or loss upon sale, with certain exceptions; in 1926, the section was amended by providing that in case of oil or gas wells the allowance for depletion shall be 27½ per cent. of the gross income, but not to exceed 50 per cent. of the net income from the property, nor be less than it would be if computed without reference to this paragraph.

The position of the plaintiffs is that the oil which they sold was property which they had held for more than two years, and thus is within the definition of "capital assets" in section 208, and that, in truth and fact, the oil is a part of the substance of the land and is limited in amount, and when they sell it, even in installments, they are parting with a part of their capital. The collector asserts that the moneys realized by a royalty owner from the operation of an oil property is ordinary income, and not within either the letter or the spirit of the exception contained in section 208; that the plaintiffs did not own the oil until it was reduced to possession, which took place within the two-year period fixed by the statute; that, prior to reduction to possession, all they owned was an incorporeal right to reduce to possession, which right was not sold during the taxable year, and the sale of which plaintiffs do not allege was the source of the income. The collector further contends that...