Commissioner of Internal Revenue v. Clarion Oil Co.

• Decision Date: 12 March 1945
• Docket Number: No. 8586.,8586.
• Citation: 80 US App. DC 41,148 F.2d 671
• Parties: COMMISSIONER OF INTERNAL REVENUE v. CLARION OIL CO.
• Court: U.S. Court of Appeals — District of Columbia Circuit

80 US App. DC 41, 148 F.2d 671 (1945)

COMMISSIONER OF INTERNAL REVENUE v. CLARION OIL CO.

No. 8586.

United States Court of Appeals District of Columbia.

Argued January 24, 1945.

Decided March 12, 1945.

Writ of Certiorari Denied June 18, 1945.

Mr. Hilbert P. Zarky, of Washington, D. C., of the Bar of the Supreme Court of Wisconsin, pro hac vice, by special leave of court, with whom Assistant Attorney General Samuel O. Clark, Jr., and Messrs. Sewall Key and Warren F. Wattles, Special Assistants to the Attorney General, were on the brief, for petitioner. Messrs. J. P. Wenchel, Chief Counsel, and Rollin H. Transue, Special Attorney, of the Bureau of Internal Revenue, both of Washington, D. C., also entered appearances for petitioner.

Mr. Floyd F. Toomey, of Washington, D. C., with whom Messrs. Ellsworth C. Alvord and C. Rudolf Peterson, both of Washington, D. C., were on the brief, for respondent.

Before GRONER, Chief Justice, and MILLER and ARNOLD, Associate Justices.

Writ of Certiorari Denied June 18, 1945. See 65 S.Ct. 1580.

GRONER, C. J.

This is a petition on behalf of the Commissioner to review a decision of the Tax Court in a case involving a personal holding company surtax determined by the Commissioner, but rejected by the Tax Court, for the calendar year 1937. Taxpayer was incorporated in 1911 for the purpose of "the establishment and maintenance of an oil company with authority to contract for the lease and purchase of the right to prospect for, develop and use coal and other minerals and petroleum." Prior to 1937 it was not a "personal holding company," but for that year the statutory requirements to bring it within that classification were found by the Commissioner to be present.

Some time prior to 1936 taxpayer acquired a three-fourths' interest in lessee rights under an oil, gas and mineral lease on land located in Harris County, Texas. This interest was acquired by assignment from the assignee of the original lessee. The five-year term of the lease expired in November, 1938, but could have continued had oil, gas, or mineral been found. In July, 1937, taxpayer assigned its interest in the lease to Humble Oil & Refining Company for a cash consideration of $120,000.00, an oil payment of $240,000.00 out of a share of oil if, as and when produced, and an overriding royalty of 1/32nd of oil which might be produced. Before expiration of the lease, Humble Oil Company in 1938 drilled on the property a "dry hole," and the lease was abandoned. Since no oil was produced, taxpayer received nothing from the lease or the assignment except the $120,000.00 cash payment received in 1937. In its corporation tax return for that year taxpayer included as taxable income the sum so received and took the statutory "depletion" deduction of $33,000.00, being 27½% of that amount. In his determination of the tax, the Commissioner held the $120,000.00 payment to be "advance royalty" or rent, and therefore personal holding company income under sub-sections (g) or (h) of § 353 of the Revenue Act of 1937.¹

The Tax Court rejected the Commissioner's holding² and decided that the payment received was neither rent nor royalty within either sub-section, and accordingly did not constitute "personal holding company income," and from that decision the Commissioner appeals to this court.³

It will thus be seen that the main question is whether the $120,000.00 cash payment was personal holding company income for the taxable year 1937, and, the other elements necessary to constitute taxpayer a personal holding company being present, the answer turns upon whether that amount was received by the taxpayer either as rents under § 353(g), or as royalties under § 353(h). The Tax Court, as we have seen, held it was neither the one nor the other. On the argument in this court the Commissioner insists primarily that it was "royalty" and only in the alternative that it might have been "rent."

We are in accord with the view of the Tax Court that the payment was not "rent," and, for the purposes of this case, we adopt the reasons stated by the court in its opinion⁴ on that subject.

The question whether the $120,000.00 cash payment was a royalty, presents a much more difficult problem, and the answer depends upon whether the term — royalty — should be construed in its usual and ordinary sense or whether it must be construed so as to give, if possible, a more nearly uniform application to the general federal scheme of taxation.⁵ The word "royalty," it is said, originated in England, where it was used to designate the share in production reserved by the Crown from those to whom the right to work mines and quarries was granted; and, generally speaking, that is the definition applied in most of the States in the interpretation of State statutes in which the term appears.⁶

In Oklahoma, where they are perhaps more frequently used than elsewhere, the words "bonus," "rental" and "royalty" are construed in their ordinary and popular sense, "bonus" meaning the cash consideration or down payment, paid or agreed to be paid, for the execution of the lease; "rental" being the consideration for the privilege of delaying the drilling operation; and "royalty" being the share of the produce reserved to the owner for permitting another to exploit and use the property.⁷ Similarly, in Kansas, royalty is said to be the share in oil and gas produced and paid as compensation for the right to drill and produce; in Montana it is the share of the production or profit paid the owner; and in Texas, the share of the produce or profit reserved by the owner for permitting another to use the property. Innumerable other similar examples might be given, but reference to the decisions of the Supreme Court involving federal taxation shows that that Court has repeatedly said that State decisions on the subject control only when the federal taxing Act, by express language or necessary implication, makes its operation dependent upon State law; hence, lacking a Congressional definition, interpretation should always be made to give uniformity to the national tax scheme.⁸ By reference to decisions of the Supreme Court, applying this rule, it convincingly appears that in cases involving claims to "depletion" deductions, the Court has consistently rejected the generally accepted definitions of the word "bonus" as describing a cash consideration paid for the execution of a lease and held it to be what is called an "advance royalty" — or, transposed, a royalty paid in advance, and in all respects subject to depletion as a royalty arising out of a share of the product reserved.⁹ This is qualified only to the extent that in addition to the bonus an "economic interest" in the oil, in place, must be reserved by the recipient of the bonus. This interest is implied from the retention of any "right to share in the oil produced."¹⁰

The inevitable result of this is to indicate that the word "bonus", as used in oil leasing parlance, is, in relation to federal taxation, included in the word "royalty;" and this meaning had become fixed and certain before Congress enacted the Revenue Act of 1934,¹¹ wherein royalty income of a personal holding company was first subjected to the surtax here under consideration. It therefore follows that the $120,000.00 received by the taxpayer, being, as it insists, a bonus, yet, connected as it was with the retention of a royalty interest in oil, was itself a "royalty" without regard to whether oil was or was not subsequently discovered and produced. And all of this, of course, goes back to the proposition, unqualifiedly adopted by the Supreme Court, that the usual acceptation of the meaning of terms or words in State court decisions is not controlling in those instances in which to do so would disarrange the uniformity of the federal tax laws. And certainly nothing would contribute more to lack of uniformity than to say on the one hand that a cash payment — called a bonus — received in consideration of an oil lease is subject to "depletion" deductions, as is uniformly held, and then to deny that it is a royalty because it lacks some of the characteristics colloquially applied to that term. The cases cited in footnote 9 fully illustrate this principle. No particular good will be accomplished in repeating the language of these cases, but in all of them, where the question was whether the bonus was a capital gain and hence taxable under the provision for capital gains and losses, or was ordinary income for which no depletion was allowed, or was a royalty, subject to depletion, the courts, including the Supreme Court, have agreed that for federal tax purposes it is in the last named class, and subject to the conditions applicable to royalties.

Accordingly, we think the Commissioner was correct in placing taxpayer in the personal holding company category and in assessing a tax on its undistributed income; and consequently, the Tax Court's decision to the contrary is reversed.

This brings us then to another question arising out of the following facts: Taxpayer for the year 1937 had net income amounting to $162,386.45. On this sum it paid when due in March, 1938, a normal tax of $14,454.02 and an excess profits tax of $1,448.80, aggregating $15,902.82. There was also distributed to its stockholders $115,000.00 in dividends. Of the $162,386.45 there thus remained "undistributed" or "accumulated" income in the amount of $31,483.63. But the Commissioner disallowed the deduction of the $15,902.82 which had accrued in 1937, in computing the taxpayer's personal holding company surtax liability. This surtax,¹² which may properly be called a penalty tax (65% of the undistributed net income up to $2,000 — 75% of the balance), amounted to $35,000.44.

The question, in this aspect, is whether the penalty tax should have been calculated on the whole amount of the difference between net income and dividends ($162,386.45 minus $115,000.00), or whether the amount of tax paid by...