Bayou Verret Land Co. Inc. v. CIR

• Decision Date: 03 January 1972
• Docket Number: No. 30347.,30347.
• Citation: 450 F.2d 850
• Parties: BAYOU VERRET LAND CO., Inc., et al., Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. Carlos and Jacqueline MARCELLO et al., Petitioners-Cross-Respondents, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Cross-Petitioner.
• Court: U.S. Court of Appeals — Fifth Circuit

450 F.2d 850 (1971)

BAYOU VERRET LAND CO., Inc., et al., Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

Carlos and Jacqueline MARCELLO et al., Petitioners-Cross-Respondents, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Cross-Petitioner.

No. 30347.

United States Court of Appeals, Fifth Circuit.

November 2, 1971.

Rehearing Denied January 3, 1972.

COPYRIGHT MATERIAL OMITTED

deQuincy V. Sutton, Meridian, Miss., Thomas J. Taylor, New Orleans, La., for petitioners.

Johnnie M. Walters, Asst. Atty. Gen., Meyer Rothwacks, Atty., Tax Div., U. S. Dept. of Justice, K. Martin Worthy, Chief Counsel, Eugene F. Colella, Atty., I. R. S., John M. Brant, Carleton D. Powell, Attys., Dept. of Justice, Washington, D. C., for respondent.

Before GOLDBERG, GODBOLD and RONEY, Circuit Judges.

GODBOLD, Circuit Judge:

Consolidated for review in this court are five appeals from similarly consolidated decisions of the Tax Court on petitions to redetermine the Commissioner's assessments of deficiencies in the tax liabilities of a number of related Louisiana taxpayers.¹ We affirm in part and reverse and remand in part.

I. Bayou Verret and Churchill Farms

During 1959-64 Bayou Verret Land Co., Inc., and Churchill Farms, Inc., derived their income almost solely from oil and gas leases covering portions of Louisiana land owned by them, approximately 1271 acres and 4200 acres, respectively. After an audit, the Commissioner determined that there were deficiencies in the corporations' income tax, and that both were personal holding companies within the meaning of and subject to the tax imposed by IRC §§ 541-547, 26 U.S.C. §§ 541-547,² for 1959-64. On petition, the Tax Court overruled these determinations with respect to some years but agreed that Bayou was a personal holding company in 1959, 1960 and 1963, and that Churchill was a personal holding company in 1959 and 1960. Bayou Verret Land Co., Inc., v. Commissioner of Internal Revenue, 52 T.C. 971 (1969).

(A) Personal holding company issues.

On appeal both corporations contend that the Tax Court erred in holding them subject to the personal holding company tax. Primarily they assert that income received from various oil and gas leases was not "personal holding company income" as defined by § 543(a) (8).

The limited number of shareholders and the absence of dividends³ prerequisite to the imposition of the tax were undisputed below. The lease income consisted solely of "lease bonus" or advance lump sums which the corporations as lessors received on the execution of various oil leases subsequently abandoned without production. It was also not in dispute that for each corporation this income exceeded 50 percent of its gross income. Thus whether each was subject to the personal holding company tax depended upon whether the lease bonus was considered to be "rent," governed by pre-1964 § 543(a) (7), or "mineral, oil, or gas royalty," governed by pre-1964 § 543(a) (8). If it were considered rent, the corporations would escape imposition of the tax since their income from the leases constituted more than 50 percent of gross income. IRC § 543(a) (7). But if it were considered mineral, oil, or gas royalty, the corporations could escape imposition of the tax only if, in addition, their allowable deductions under IRC § 162 exceeded 15 percent of gross income for each of the years in question. IRC § 543(a) (8) (B).

Overruling its earlier decision in Porter Property Trustees, Ltd., 42 B.T.A. 681, 691 (1940), and following the decision in Commissioner of Internal Revenue v. Clarion Oil Co., 80 U.S.App.D.C. 41, 148 F.2d 671 (1945), the Tax Court ruled in favor of the Commissioner and held the bonuses to be mineral royalties, even though the leases in respect of which the bonuses were received were subsequently abandoned without production. Both Clarion Oil and the court below proceeded by analogy to decisions holding lease bonus subject to the same tax treatment as production royalties, e. g., Burnet v. Harmel, 287 U.S. 103, 53 S.Ct. 74, 77 L.Ed. 199 (1932), including the allowance for depletion, e. g., Murphy Oil Co. v. Burnet, 287 U.S. 299, 53 S.Ct. 161, 77 L.Ed. 318 (1932); Palmer v. Bender, 287 U.S. 551, 559, 53 S.Ct. 225, 77 L.Ed. 489, 494 (1933), even where no production had occurred in the year in which the bonus was received and the deduction for depletion taken, Herring v. Commissioner of Internal Revenue, 293 U.S. 322, 55 S.Ct. 179, 79 L.Ed. 389 (1934). Relying on the fact that these decisions antedated the enactment of the scheme of taxation of personal holding companies in 1934, Revenue Act of 1934, 48 Stat. 680, 751-752, both Clarion Oil and the Tax Court in the present litigation reasoned that when Congress employed the term "royalties" in the 1934 statute, and "mineral, oil, or gas royalties" in the 1937 revision, Revenue Act of 1937, 50 Stat. 813, it intended the term to include lease bonus, in accordance with prior Supreme Court construction of the income tax laws. Clarion Oil, supra, 148 F.2d at 674; 52 T.C. at 979. In both decisions this conclusion was reached despite the fact that the leases had been condemned and abandoned without production.

This argument has merit, but we do not think it conclusive, particularly because, although the Supreme Court has held that lease bonuses are regarded as advance royalties, and are given the same tax consequences, Anderson v. Helvering, 310 U.S. 404, 409, 60 S.Ct. 952, 84 L.Ed. 1277, 1281 (1940), it has not held that they are royalties, and indeed, cash bonus payments are sometimes given different tax treatment. In particular, when land subject to an oil lease, on which a cash bonus has been previously paid, is condemned without any actual production, the previously deducted depletion is by the Commissioner's regulations required to be restored to income in the year of condemnation, Treas.Reg. 1.612-3(a) (2). The Supreme Court has upheld this regulation, Douglas v. Commissioner of Internal Revenue, 322 U.S. 275, 64 S.Ct. 988, 88 L.Ed. 1271 (1944). Thus, it does not follow, from the fact that bonus payments are in some instances treated for income tax purposes like production royalties, that "mineral, oil, or gas royalties" as used in pre-1964 § 543(a) (8), necessarily includes lease bonus.

Nevertheless, we are persuaded that lease bonus should be treated as oil or gas royalty within the meaning of § 543(a) (8), and that the Tax Court's ultimate ruling must stand. It is the statute itself which draws us to this conclusion. The problem to which the personal holding company tax is directed is the accumulation of passive investment income in closely held nonoperating companies, a device employed by high tax-bracket individuals to shield their income from the high graduated individual tax rates while exposing it only to the lower flat rate corporate income tax. The scheme of personal holding company taxation was enacted when Congressional studies revealed that the accumulated earnings tax of IRC § 531 was inadequate to police such abuses. Bittker § Eustice, Federal Income Taxation of Corporations and Shareholders, § 6.20 (2d ed. 1966). Since the original enactment of the statute in 1934, "royalties" have been included as one of the categories of personal holding company income, Revenue Act of 1934, § 351, and since 1937 both "mineral, oil, and gas royalties," and "rents" have been denominated potential personal holding company income,⁴ Revenue Act of 1937, § 1. Because it seems to us that the type of lease bonus here under consideration is precisely the sort of passive investment income with which the statute is concerned⁵—indeed, since the term "lease bonus" semantically appears to straddle the statutory categories of "mineral, oil or gas royalties" and "rent"—we have no doubt that the lease bonus falls within one category or another.⁶ The question is which one.⁷

We conclude that it is more agreeable to the statutory scheme for lease bonus to be classified as "mineral, oil, or gas royalty." As we have noted,⁸ the primary difference between the pre-1964 treatment of rents and oil or gas royalties as personal holding company income is that the former were not considered such income if they exceeded 50 percent of gross income, while in the latter case there was the additional requirement that the corporation's § 162 deductions exceed 15 percent of gross income. "The 15 percent business expense test is designed to separate operating companies from holding companies by demanding a minimum level of business activity * * *." Bittker & Eustice, supra, § 6.22.3. In other words, this requirement distinguishes corporations whose principal, if not sole, income generating assets consist of profitable mineral leases, from companies which, in addition, actually carry on substantial operating activities.⁹

It appears to us that § 543(a) (7), governing rents, contains no 15 percent business deduction requirement because the corporation receiving substantial income from actual rentals on property will frequently be the owner of developed land, undergoing the normal expenses of maintaining and operating its income producing assets. Thus, there often are likely to be inherent safeguards that such corporations are at least pro forma operating companies. This is not as likely with the corporation whose income is from oil leases covering property which is typically otherwise undeveloped, to say nothing of corporations which have acquired leases by assignment and do not even own the lands subject to the leases.

As is the case with corporations receiving income from oil production royalties, and unlike real estate operating companies, there are no inherent safeguards that corporations such as Bayou and Churchill, which receive most of their income in the form of lease bonus, are genuine operating companies rather than holding companies. Accordingly, we conclude that it would conform to the purposes of the statutory scheme for the lease bonus...