COMMISSIONER OF INTERNAL REVENUE v. PG Lake, Inc.

• Decision Date: 01 February 1957
• Docket Number: No. 16126.,16126.
• Citation: 241 F.2d 71
• Parties: COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. P. G. LAKE, Inc., Respondent.
• Court: U.S. Court of Appeals — Fifth Circuit

241 F.2d 71 (1957)

COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. P. G. LAKE, Inc., Respondent.

No. 16126.

United States Court of Appeals Fifth Circuit.

February 1, 1957.

Melva M. Graney, Hilbert P. Zarky, John N. Stull, Attys., Dept. of Justice, Washington, D. C., Charles K. Rice, Asst. Atty. Gen., John Potts Barnes, Chief Counsel, Claude R. Marshall, Sp. Atty., I. R. S., Washington, D. C., for petitioner.

Harry C. Weeks, Fort Worth, Tex., for respondent. Weeks, Bird, Cannon & Appleman, Fort Worth, Tex., of counsel.

Before HUTCHESON, Chief Judge, and HOLMES and BORAH, Circuit Judges.

HUTCHESON, Chief Judge.

This appeal by the commissioner from one of a series of adverse decisions¹ of the Tax Court presents the single question whether $600,000 received as consideration for an assignment of overriding oil payment interests limited to $600,000 carved out of two oil and gas leaseholds or working interests² is taxable to the seller as ordinary income subject to depletion rather than, as the Tax Court held, as long term capital gains under Sec. 117 of the 1939 Internal Revenue Code, 26 U.S.C.A. § 117.

Here vigorously assailing the decision of the Tax Court in this and the other cases, on the ground that they were all based on the premise that all oil payment assignments constitute sales of capital assets entitled to capital gains treatment under Sec. 117, and declaring, "That premise was specifically rejected in the Hawn case", the commissioner thus continues:

"In the present case, as in some of the other appealed cases, the assignor was a leasehold owner which created the oil payment right not just, like the taxpayer in Hawn, the owner of a larger oil payment right. For that reason, the case calls for an even more basic application of the anticipatory assignment of income rule than did Hawn. Not only that, any attempt to treat the oil payment assignment as a sale of property according to ordinary property law concepts merely confirms the conclusion that it was an anticipatory assignment of income.

"Our position here in no way conflicts with this court\'s decision in Caldwell v. Campbell, 218 F.2d 567 where * * * the assigned oil payment rights were carved out of royalty interests * * *".

Having thus, as he thinks, cleared the ground for an all out and unembarrassed attack on the Tax Court's ruling, the commissioner assails it: (1) as contrary to our decision in Hawn's case in that it treats as substantial an interest which, under the teachings of that decision, is insubstantial; (2) in that what was here transferred was not any part of the leasehold interest, the "property representing income producing property, the vendor's capital investment", it was a transfer merely of a right to receive future income and, under the teachings of Burnet v. Harmel, 287 U.S. 103, 53 S.Ct. 74, 77 L.Ed. 199, and the Corn Products case, Corn Products Refining Co. v. Commissioner, 350 U.S. 46-52, 76 S.Ct. 20, 24, 100 L.Ed. 29,³ it was not entitled to Sec. 117 preferential treatment; (3) in that, if contrary to No. (2) above, the oil payment is treated as a sale of income producing property, it had not been held for six months because it did not come into existence until the oil payment was created; and (4) in that the property sold was the oil itself and thus was property "primarily held for sale in the ordinary course of business", and specifically excluded from capital gains treatment.

In reply to these contentions, respondent, insisting that all prerequisites to long term capital gains treatment, if there was a sale of "property" or "real property used in the trade or business" within Sec. 117 I.R.C. of 1939, are here present, urges upon us that whether or not there was such a sale here is ruled by Ortiz Oil Co. v. Commissioner, 5 Cir., 102 F.2d 508 and Caldwell v. Campbell, 5 Cir., 218 F.2d 567, and not by Commissioner of Internal Revenue v. Hawn, 5 Cir., 231 F.2d 340.

Arguing that the first two cases treat similar transactions to these as sales, that the Hawn case is clearly distinguishable and that petitioner's arguments have heretofore been rejected by this court in Caldwell v. Campbell, respondent points out that a glance at the table of cases in commissioner's brief and in the brief of Collector Campbell in Caldwell v. Campbell will show that commissioner's opposing arguments here are but an expanded repetition of those advanced in that case.

Insisting that the transaction under consideration was an assignment of a part of respondent's property interests in the two leases, the respondent cites in support Commissioner of Internal Revenue v. Fleming, 5 Cir., 82 F.2d 324; Columbus Oil & Gas Co. v. Commissioner, 5 Cir., 118 F.2d 459; Thomas v. Peckham Oil Co., 5 Cir., 115 F.2d 685; Lee v. Commissioner, 5 Cir., 126 F.2d 825; and Fleming v. Campbell, 5 Cir., 205 F.2d 549.

They recall too that the Supreme Court of the United States, this court, the Supreme Court, and the Intermediate Appeal Courts, of Texas⁴ have held that oil and gas leases, royalty interests, overriding royalty interests, and oil payments are interests in land, and that the Texas courts have held that these interests, are subject to ad valorem taxes, to statute of frauds treatment as real estate and in cases of intestacy pass as real estate.

On the commissioner's general position that oil payments carved out of working interests differ from royalties so carved, respondent, quoting from Tennant v. Dunn, supra, 130 Tex. at page 290, 110 S.W.2d at page 56:

"The interest assigned or conveyed by the instrument is in the nature of an overriding royalty. The assignment gives to Mrs. Dunn, as the reservation of an ordinary overriding royalty gives to or retains in the grantor or assignor, the right to a certain quantity of oil taken from the land, delivered as it is produced, free of charges or expenses of production or operation. * * * It is our opinion that the instrument under consideration conveys an interest in the land * * *"

points to the uniform course of decision that oil payments are in law and in fact of the same nature, indeed are identical, with royalties, except that a royalty is not limited as to duration and an oil payment is.

To commissioner's third contention that respondent did not have the requisite six months holding period for the oil payment interest conveyed, a contention on its face requiring the wholly untenable postulate that respondent, in and by the act of conveying the oil payment, acquired it, respondent points to its complete refutation in the stipulation that respondent had owned and held the leases for productive use in its trade or business of producing oil and not for sale for several years prior to Dec. 29, 1950, and to the fact that it is obvious that what respondent conveyed, and the only thing that it could convey, was a part of the estate which it acquired in the acquisition of the leases.

As to his fourth contention, that, in assigning an interest in the leases, respondent did not assign any part of the property held by it for producing income but assigned merely the oil, the property held for sale in its daily business, and that this must be so because the interest of any oil payment owner is only in the oil as personal property, respondent quotes from the leading case of Tennant v. Dunn, supra, in which, after stating that the particular instrument in question in that case, which carved an oil payment out of a working or leasehold interest, did not purport to convey oil in place, and that the ultimate right of Mrs. Dunn was a right to a certain quantity of oil after it was produced from the well, the same to be delivered to her free from any charges for production or operation, went on to say:

"It does not follow, however, that the instrument does not create an interest in land or that it evidences merely a debt to be paid out of oil produced. The oil and gas lease operated to invest the lessee with a determinable fee in the oil and gas in place. * * * The instrument above set out under which Mrs. Dunn claims follows the form ordinarily used by a lessee in assigning or conveying an interest in the leasehold estate. It is not a promise to pay money. It is not a contract for the sale and delivery of oil as personalty after production, but it undertakes to invest the assignee, and we think it does invest her, presently with a right or interest in what the assignor owned. * * * A part of the lessee\'s right or interest is assigned, not a fractional interest in the entire leasehold estate but the absolute right, without charges for production or operation, to a fractional part of the oil as and when it is produced from a well on the leased land until the assignee has received oil of the total value of $25,000. The total quantity of oil to be delivered to the assignee is not a fixed fraction of the entire production, and is not a certain number of barrels, but it is measured by value according to a specified standard. 130 Tex. at page 290, 110 S.W.2d at page 56. * * * The gist of the opinion in Sheffield v. Hogg is that oil and gas royalties, whether payable in kind or in money, * * * should be adjudged to be present interests in land rather than mere rights in personalty at some uncertain date, because they are profits arising out of land, and, further, because such classification, which accords with the practice in the oil and gas industry, furnishes a stability highly important, if not essential, to the structure of that business. * * 130 Tex. at page 292, 110 S.W.2d at page 57.

"The fact that Mrs. Dunn\'s purchase of the interest was highly speculative, and that she might realize either nothing or very large profits, does not affect the nature of the interest. Most investments in oil properties or production are speculative. Mrs. Dunn did not become by virtue of the assignment a mining partner or a joint adventurer, for it gave her, not merely a part of the profits of the enterprise, but an interest in

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