AT Jergins Trust v. Commissioner of Internal Revenue

• Decision Date: 08 September 1932
• Docket Number: No. 6768.,6768.
• Citation: 61 F.2d 92
• Parties: A. T. JERGINS TRUST v. COMMISSIONER OF INTERNAL REVENUE. COMMISSIONER OF INTERNAL REVENUE v. A. T. JERGINS TRUST.
• Court: U.S. Court of Appeals — Ninth Circuit

61 F.2d 92 (1932)

A. T. JERGINS TRUST v. COMMISSIONER OF INTERNAL REVENUE.

COMMISSIONER OF INTERNAL REVENUE v. A. T. JERGINS TRUST.

No. 6768.

Circuit Court of Appeals, Ninth Circuit.

September 8, 1932.

Thomas R. Dempsey, A. Calder Mackay, Marc F. Mitchell, and George G. Witter, all of Los Angeles, Cal., for A. T. Jergins Trust.

G. A. Youngquist, Asst. Atty. Gen., Sewall Key, Andrew D. Sharpe, and Francis H. Horan, Sp. Assts. to the Atty. Gen. (C. M. Charest, Gen. Counsel, and Mason B. Leming, Sp. Atty., Bureau of Internal Revenue, both of Washington, D. C., of counsel), for Commissioner of Internal Revenue.

Before WILBUR and SAWTELLE, Circuit Judges, and NORCROSS, District Judge.

WILBUR, Circuit Judge.

Petitioner seeks to review the determination of the United States Board of Tax Appeals upon a determination by the Commissioner of Internal Revenue proposing deficiencies in income taxes for the calendar years 1922, 1923, and 1924. The Board of Tax Appeals rejected the contention of the petitioner that it was exempt from income tax, and sustained its contention with reference to the manner of the determination of the depreciation and depletion items. Petitioner appeals from the former, and the Commissioner from the latter, part of the decision. If the contention of the A. T. Jergins Trust is sustained, it will be unnecessary to consider the Commissioner's petition. We will refer throughout to the A. T. Jergins Trust as "the petitioner," and to the Commissioner of Internal Revenue as "the respondent" or "the Commissioner."

The facts are stated in the opinion of the Board of Tax Appeals, and are not in dispute. We will state the salient facts and refer to the findings of the Board of Tax Appeals for a more detailed statement.

In 1911 the city of Long Beach issued bonds, and with the proceeds thereof purchased the water system which had theretofore been furnishing the city and the inhabitants thereof with water. It is stated in the opinion and emphasized in the brief on behalf of the city that the acquisition of this waterworks was made necessary by reason of the unsanitary condition of the water mains and pipe lines resulting from rust and decay which permitted the water to escape, and, after becoming contaminated, to return to the pipes of the distributing system. We mention this fact, but attach no importance to it. Among the assets thus purchased by the city was a tract of 600 acres of waterbearing land. This land was the source of all the water used by the city's distributing system. The water was obtained by sinking wells to a subterranean supply. Part of the water procured and distributed was used for fire protection. Some years later oil was discovered in the vicinity of the water-bearing land of the city, and later oil was successfully developed and produced upon said land. On April 11, 1922, the city, as lessor, entered into a lease with the petitioner for about 140 acres of its water-bearing land, which was then, and is still, used for the procuring of water for the city and its inhabitants. It is sufficient, with reference to this lease, to state that it is an ordinary lease for the development of oil, providing that the oil produced by the lessee should be divided in the proportion of 40 per cent. to the city and 60 per cent. to the lessee. The lessee was required to pay all the expenses of exploration and development. With reference to the payment of taxes, the lease stipulated as follows:

"Taxes: The lessee shall pay all taxes and assessments which are levied or assessed upon any property which it may place on the said above described lands during the term hereof; and/or upon the oil or other hydrocarbon products stored on said lands by the lessee and not belonging to the lessor, and upon the mineral rights and interest of the lessee in said lands. All charges, taxes and assessments imposed by the state of California, United States of America, or any political subdivision of either thereof, upon said lands, or upon any part or parcel thereof, except upon the improvements placed thereon by the lessee, shall be paid in the following proportions: Forty (40%) per cent thereof by the lessor, and sixty (60%) per cent thereof by the lessee; provided, however, that the lessee shall at its sole and exclusive expense, pay and discharge all fees which are now or may hereafter be required to be paid by the state of California through the State Mining Bureau and the office of the State Oil and Gas Supervisor, or through such other department of the state of California which may be created for that purpose by legislative enactment."

The surface of the land is used for a variety of purposes. In connection with the water system, the city employed about 50 men whose headquarters were on the 600 acres. It maintains thereon a pumping plant, service department, blacksmith shop, salvage yard, a garage and residence, all of which are used in connection with the water plant. In addition to two oil and gas leases, of one of which petitioner is the lessee, the said tract of 600 acres has on it about 60 tenants who hold under leases or permits from the city. The business of these tenants includes airplane repair, hangars for aircraft, oil-well supplies, telephone, storage plants, cracking plants, oil-skimming plants, dehydration plants, gasoline absorption plants, and farming. These leases and permits were then and are of a temporary nature; can be terminated on short notice; and are made subject to the right of the city to use the property for water purposes. While a large amount of revenue has been derived by the city from its water-bearing lands as royalty upon the oil produced therefrom, it is clear that such production is altogether incidental to the main purpose and use of the land. We are not, therefore, dealing with a purely business venture in which the city, for the mere purpose of producing revenue for its treasury, engages upon business entirely distinct from its governmental functions.

The general principles with relation to the right of the federal government to tax the instrumentalities of the state, and vice versa, are well settled, and have been applied in a great many cases by both state and federal courts. The only difficulty is in the application of these general principles to the unique situation shown by the record in the case at bar. We are not, however, left solely to the application of these general principles for the determination of the questions involved in this case. The Supreme Court has recently had occasion to consider a number of similar leases and to determine the right of the state or federal government to tax the income derived therefrom by the lessee. In the most recent of these cases, decided April 11, 1932, Burnet v. Coronado Oil & Gas Co., 285 U. S. 393, 52 S. Ct. 443, 444, 76 L. Ed. 815, the Supreme Court passed upon the power of the federal government to tax such proceeds derived from school lands belonging to the state of Oklahoma, and held that the federal government had no power to tax such income so derived. In this opinion the Supreme Court affirmed the decision of the Court of Appeals of the District of Columbia (60 App. D. C. 233, 50 F. (2d) 998) reversing a decision of the Board of Tax Appeals (14 B. T. A. 1214) which sustained the Commissioner of Internal Revenue in the assessment of income taxes upon income so derived by the lessee. In the case at bar the Board of Tax Appeals predicated its...