COMMISSIONER OF INTERNAL REVENUE v. Crawford

• Decision Date: 21 April 1945
• Docket Number: No. 10885.,10885.
• Citation: 148 F.2d 776
• Parties: COMMISSIONER OF INTERNAL REVENUE v. CRAWFORD.
• Court: U.S. Court of Appeals — Ninth Circuit

148 F.2d 776 (1945)

COMMISSIONER OF INTERNAL REVENUE v. CRAWFORD.

No. 10885.

Circuit Court of Appeals, Ninth Circuit.

April 21, 1945.

Samuel O. Clark, Jr., Asst. Atty. Gen., and Sewall Key, Robert N. Anderson, Hilbert P. Zarky, and Maryhelen Wigle, all of Washington, D. C., for petitioner.

Sidney D. Krystal and Oscar Moss, both of Los Angeles, Cal., for respondent.

Before DENMAN, STEPHENS, and HEALY, Circuit Judges.

DENMAN, Circuit Judge.

Petitioner seeks a review of the Tax Court's order holding that the taxpayer, owner of California oil land, who has made two leases of portions thereof to the Standard Oil Company of California, the lessee to drill for and produce oil therefrom, which leases are terminable by breach of the drilling and other agreements of the lessee, is entitled to depletion deductions for the agreed royalty of a percentage of the net profits of the lessee from its sale of oil extracted from the leased land. The tax years in question are 1938, 1939, and 1940.

The Tax Court relied, in part, upon our decision in Commissioner of Internal Revenue v. Felix Oil Co., 144 F.2d 276, in which we decided that such a lessor is entitled to such deductions for the tax years 1938 and 1939 as a part of the "gross income from the property" under § 114(b) (3) of the Revenue Code. 26 U.S.C.A. Int.Rev.Code, § 114(b) (3). This same section is controlling for the tax year 1940.

Petitioner's brief and argument in the instant case present the same argument, based upon the same authorities, as in the Felix case, save that it cites the recent case of Commissioner of Internal Revenue v. Kirby Petroleum Co., 5 Cir., 148 F.2d 80, 83, Judge Hutcheson dissenting.

In that case the majority opinion states of such a payment of net profits as here reserved that it "is not the payment in kind of royalty oil or its equivalent" and contends that the net profit from the operation and sale of the oil paid to the owner of the land is not part of the gross income the landowner receives from the property. Unless the majority opinion can be distinguished on the ground that in Texas the title to the oil passes to the lessee,¹ whereas in California² it remains in the lessor, we are not in accord with its holding.

The Supreme Court cases relied upon in the Kirby Petroleum case are all based on the absence of a property interest in the oil property at the time the income from its sale is paid. In Helvering v. O'Donnell, 303 U.S. 370, 58 S.Ct. 619, 620, 82 L.Ed. 903, as here, "The question is whether respondent taxpayer had an interest, that is, a capital investment, in the oil and gas in place." It was held that the taxpayer's prior interest was merely that of a stockholder in the corporation owning the oil land and that, as stockholder, he did not have any capital interest in the corporation's property. Hence he was not entitled to depletion on the "one-third of the net profits derived from the development and operation of the * * * properties."

In Helvering v. Elbe Oil Land Development Co., 303 U.S. 372, 58 S.Ct. 621, 82 L.Ed. 904, the taxpayer had conveyed all his interest in the oil land. Relying upon the O'Donnell case, the Supreme Court held that the net profits from the operation agreed to be paid after title had passed from the taxpayer were not subject to depletion.

In these two cases all the Supreme Court's discussion of capital interest in the oil becomes meaningless if a royalty is not subject to depletion if payable in "net profits" of the operation. Cf. ...