APPEAL OF GEORGE, BESSIE, DOUGLAS

• Decision Date: 27 January 1925
• Docket Number: Docket No. 288.
• Citation: 1 BTA 372
• Parties: Appeal of GEORGE P. and BESSIE P. DOUGLAS.
• Court: U.S. Board of Tax Appeals

1 B.T.A. 372 (1925)

Appeal of GEORGE P. and BESSIE P. DOUGLAS.

Docket No. 288.

Board of Tax Appeals.

Submitted November 24, 1924.

Decided January 27, 1925.

H. A. Mihills, C. P. A., for the taxpayer.

A. Calder Mackay, Esq.(Nelson T. Hartson, Solicitor of Internal Revenue) for the Commissioner.

Before GRAUPNER, LITTLETON, and SMITH.

This appeal came on for hearing on November 13 and November 17, 1924.Witnesses testified in behalf of the taxpayer and in behalf of the Commissioner.From the testimony and documentary evidence introduced the Board makes the following

FINDINGS OF FACT.

1.The taxpayers are husband and wife; are residents of Minneapolis, Minn., and for the calendar years 1918 and 1919 filed joint individual income tax returns.

2.A deficiency letter was mailed to the taxpayers on August 2, 1924, showing deficiencies in tax as follows:

1918 _______________________________________________ $16,588.90
                1919 _______________________________________________  42,284.77
                                                                    ___________
                                                                      58,873.67
                

3.The original income tax returns filed for 1918 and 1919 showed no tax due and no tax has been assessed upon them.They showed royalties received from mines as follows:

                                                1918        1919
                Pettit mine _______________________________  $28,243.79  $21,271.40
                Corsica mine ______________________________   75,145.69  201,152.60
                Chemung mine ______________________________    5,000.00    5,000.00
                Tioga mine ________________________________    3,000.00    3,000.00
                Emmett Mine (Roberts mine) ________________    6,577.98    3,813.84
                                                           ____________  __________
                                                             117,967.46  234,237.84
                

Deductions for depletion were claimed on the above returns in amounts equal to the royalties received from the respective mines.

4.The taxpayers kept their books of account for the years 1918 and 1919 on a cash receipts and disbursements basis and their income tax returns were made upon that basis.

5.The principal income of the taxpayers for the years 1918 and 1919 was from royalties received by Bessie P. Douglas as fee owner of an undivided one-half interest in the iron mines, above enumerated, located on the Mesaba Range in Minnesota.Her interest in the Pettit mine was acquired prior to 1913.Two-thirds of her interest in the other four mines was acquired by inheritance from her father, C. H. Pettit, who died on May 11, 1914, and the balance by deed from her mother, Deborah M. Pettit, during the year 1916.

6.The mines named were and long prior to 1913 had been under lease to certain iron ore operators who paid to the fee owners stipulated royalties on tons of ore mined in all cases with the exception of the Corsica mine.In lieu of a stipulated royalty per ton of ore mined from the Corsica mine the lessee paid 40 per cent of the net profits from operation under a so-called profit-sharing lease.This was entered into September 30, 1897, and provided in part as follows:

IV.In consideration of said lease, the party of the second part (the lessee) agrees to and with the said parties of the first part, that he will advance all moneys necessary for the said exploration and the development and operation of any mine or mines found upon said lands or any part thereof, including all necessary machinery, buildings, structures, fixtures, and the like, and that he will use his best endeavors to obtain money on the most advantageous terms for such purposes, and for the operation of such mine or mines.

And it is agreed that the second party shall keep a correct and strict account of all moneys received for sales of ore, and of all the proceeds of said mine or mines, or the disposition of any machinery, structure, or other property used in connection therewith, and that for all moneys so advanced and expended by said second party, as aforesaid, for such explorations, and for buildings, structures, fixtures, and other improvements constituting the "plant" of said second party or assigns, for said mining operations, he or they shall be allowed for and repaid out of the gross earnings or proceeds of said mines, sales, or mining operations; but only twenty (20) per cent of said expenditures shall be allowed and charged up against said gross earnings in any one year.

And it is also agreed that said second party shall be allowed interest at the rate of six per cent (6%) per annum on all amounts or balances for such expenditures remaining unpaid, which interest may be charged up annually against the gross earnings or profits of said mine or mines.All such expenditures shall be prudently and economically made and for the best interests of all the parties to this agreement.

It is expressly understood and agreed that the parties of the first part shall not be subject either directly or indirectly to any liability whatever in the premises for any obligation, debt, contract, or undertaking assumed or made by the party of the second part or his assigns, in any manner connected with said mining operations.

V.It is further mutually agreed that there shall be paid to the said first parties, their legal representatives or assigns, by the said second party, his legal representative or assigns, as in the nature of royalty, each and every year during the continuance of this lease, a sum equivalent to forty per cent (40%) of the net profits of the sales and proceeds of said mines or mining operations for such year, after deducting the sum or sums herein allowed to be charged off and deducted from the amount of the gross earnings and sales for such year.And that their proportion of said net profits shall be advanced to them, said first parties, pro rata with any amount or amounts thereof received or appropriated by the said second party or his assigns, and all account of the mining operations for each year shall be made and rendered on the first day of December of such year, during the continuance of this lease; and said forty per cent (40%) of the net profits of each year's business shall be paid to said first parties on or before December 20th of such year.Each business year under this agreement shall end with November 30th.

And the party of the second part shall, upon the said first day of December of each year, make and transmit to the said first parties an exact and truthful statement of the business for the year ending with said 30th day of November, and of the amount of iron removed and sold during said year.

* * * * * *

It is by the said parties hereby mutually understood and agreed, that if the said party of the second part shall fail to render his account of the operation of said mine, as aforesaid, on the first day of December of each year, or within twenty (20) days thereafter, or if the said second party shall fail to pay over to said first parties their proportion of the said net profits as herein provided, and the same shall remain in default for the period of sixty (60) days, or if the said second party shall fail to keep and perform any of the promises, covenants, or conditions herein expressed, to be by them kept and performed, then said first parties, their representatives and assigns shall have the right to terminate this lease and agreement at any time, by posting a written notice of termination in a conspicuous place at the mine or mines on said land, * * *.

VI.And it is agreed that the said parties of the first part shall be entitled to have, own, and possess an undivided four-tenths (4/10) interest in all improvements, structures, buildings, fixtures, appliances, and equipments so to be erected, placed, and made on said lands or any part thereof, during said term, as soon as and to the extent that the same shall be paid for out of the said gross earnings and sales.

7.Although the Corsica mine lease contained a covenant providing that 40 per cent of the net profits of each year's business shall be paid to the lessors on or before December 20 of each year it proved impracticable for the lessee to live up to this covenant.The taxpayers

"purely for the use and the benefit of the Pickands-Mather Company(lessee) * * * allowed them to hold the payments until January of the succeeding year, for their convenience only.* * * They settled with the Lackawanna Steel, and they said their books were all closed on December 31st, but they did not always get their payments until some time in January, and therefore we agreed that they should pay us as they got them in January.In fact I have run over into February before we got our payments."(Testimony of George P. Douglas.)

8.On January 1, 1919, the lease of the Corsica mine made in 1897 was canceled and a new lease entered into under the terms of which the taxpayers received a stipulated royalty as in the case of the four other mines.Under the new lease the taxpayers received their royalties quarterly.

9.During the year 1919 the taxpayers received a total of $201,152.60 in royalties from the Corsica mine.Of this amount $91,099.07 was received in February, 1919, and represented the taxpayers' portion of the profits from the operation of the mine (in lieu of royalties) under the lease which was canceled as of December 31, 1918; the balance of the amount, $110,053.53, represented royalties upon ore mined during the calendar year 1919.

10.The amounts of depletion claimed as deductions from gross income in the taxpayers' original tax returns for 1918 and 1919 were $117,967.46 and $234,237.84, respectively.Upon an audit of the returns by the...