Douglas v. Commissioner of Internal Revenue

• Decision Date: 07 April 1943
• Docket Number: No. 12461-12464.,12461-12464.
• Citation: 134 F.2d 762
• Parties: DOUGLAS v. COMMISSIONER OF INTERNAL REVENUE. COMMISSIONER OF INTERNAL REVENUE v. DOUGLAS. ROBINSON'S ESTATE et al. v. COMMISSIONER OF INTERNAL REVENUE. DALRYMPLE v. SAME.
• Court: U.S. Court of Appeals — Eighth Circuit

134 F.2d 762 (1943)

DOUGLAS v. COMMISSIONER OF INTERNAL REVENUE.

COMMISSIONER OF INTERNAL REVENUE v. DOUGLAS.

ROBINSON'S ESTATE et al. v. COMMISSIONER OF INTERNAL REVENUE.

DALRYMPLE v. SAME.

Nos. 12461-12464.

Circuit Court of Appeals, Eighth Circuit.

April 7, 1943.

Kimball B. DeVoy, of Minneapolis, Minn. (James E. O'Brien, of Minneapolis, Minn, on the brief), for taxpayers.

Louise Foster, Sp. Asst. to Atty. Gen. (Samuel O. Clark, Jr., Asst. Atty. Gen., and Sewall Key and A. F. Prescott, Sp. Assts. to Atty. Gen., on the brief), for Commissioner of Internal Revenue.

Before GARDNER, SANBORN, and THOMAS, Circuit Judges.

THOMAS, Circuit Judges.

These appeals of three taxpayers from a decision (46 B.T.A. 943) of the United States Board of Tax Appeals, now the United States Tax Court, and a cross appeal of the Commissioner, present two problems for determination: (1) Whether Article 23(m) — 10(c) of Treasury Regulation 94 promulgated under the Revenue Act of 1936 is valid; and (2) if the regulation is valid, may the taxpayer in the taxable year exclude a depletion deduction taken in a former year when no tax benefit resulted from the deduction in the earlier year?

Both these problems have heretofore been determined by this court. In a similar case, Lamont v. Commissioner, 8 Cir., 120 F.2d 996, the court held the regulation to be valid, and in Harwick v. Commissioner, 8 Cir., 133 F.2d 732, the tax benefit theory was held to be invalid. Since the taxpayers contend that these cases are distinguishable from the Lamont case, supra, it will be necessary to examine the facts and the issues.

On July 1, 1929, four owners of an iron mine in Minnesota leased it to an operating company for a term of 30 years. The lease provided for the payment of minimum royalties annually whether ore was extracted or not. Royalties paid in advance of extraction were to be applied on ore mined later. The lessee was given the right to cancel the lease; and this right was exercised and the lease terminated July 1, 1937, without any ore having been removed from the mine during the existence of the lease.

While the lease was in force the agreed royalties were paid to the lessors or their successors and returned by them as gross income in the years received. In the same years deductions for depletion were taken and allowed. For 1937, the year in which the lease was terminated, the Commissioner, pursuant to the provisions of paragraph (c) of Article 23(m) — 10 of Regulations 94, promulgated under the Revenue Act of 1936, included in the gross income of the several taxpayers sums corresponding to the aggregate amounts of the deductions taken by each of them, or of their transferors, during the years the lease was in force from 1929 to 1937.

The case of the taxpayer Douglas differs from the others in that, although she took and was allowed a depletion deduction for the year 1933 in the amount of $4,958.05, her net loss for that year before taking the deduction was $8,989.46. This situation gives rise to the second question presented for decision.

Upon appeal to the Board of Tax Appeals the Commissioner's action in including in taxable income for 1937 amounts equivalent to the depletion deductions taken and allowed in prior years was sustained in all of the cases involved except as to the $4,958.05 in the Douglas case. In respect of this item the Commissioner was reversed on the ground that the deduction in 1933 did not offset a taxable income, that is, that the taxpayer received no tax benefit from the deduction.

The contention of all the taxpayers in this court is that the Board erred in sustaining the action of the Commissioner in including sums corresponding to the aggregate depletion deductions of prior years in taxable income of 1937. The taxpayers insist that the regulation, which with the statute is copied in the margin,¹ is invalid because (1) unreasonable and (2) in conflict with the statute.

The taxpayers' charge of invalidity is directed against the last phrase of paragraph (c) of Article 23(m) — 10 of Regulations 94. This paragraph provides that if depletion deductions are allowed for advance royalties and no production occurs during the life of the lease, "the lessor shall adjust his capital account by restoring thereto the depletion deductions made in prior years on account of royalties of mineral paid for but not removed, and a corresponding amount must be returned as income for the year in which the lease expires, terminates, or is abandoned." (Italics supplied.)

The taxpayers' only "essential quarrel" is with the phrase printed in italics, although the validity of all of paragraph (c) is questioned. The objection to the regulation is based upon the claim (1) that it requires income received in one year to be included in the income of a later year in which it was not received; (2) that it cumulates income received in each of a series of years and taxes it as if received in one year; and (3) that the regulation thus imposes a penalty upon the taxpayer, is harsh and unreasonable, lacks common sense justification, is vicious in its results, is not equitable, and violates the statute.

Section 23(m) of the Revenue Act of 1936, supra, has been in the law continuously in substantially similar form beginning with the Revenue Act of 1918; and Article 23(m) — 10(c) of Regulations 94 had its beginning in Regulations 45 under the Act of 1918 and has existed in the regulations ever since. It was approved in effect by the Supreme Court in Murphy Oil Co. v. Burnet, 287 U.S. 299, 53 S.Ct. 161, 77 L.Ed. 318. But in Herring v. Commissioner, 293 U.S. 322, 328, 55 S.Ct. 179, 181, 79 L.Ed. 389, decided after the Murphy Oil Co. case, the court said: "As to income tax liability in the year of termination of the lease, on account of bonus paid at the execution of the lease, if no mineral has been extracted, we express no opinion." Because of this expression of the Supreme Court, the taxpayers contend that the validity of the regulation is an open question. Congress, however, has shown its approval of the regulation by the repeated reenactment of the statute without any change in the regulation. Burnet v. Thompson Oil & Gas Co., 283 U.S. 301, 307, 308, 51 S.Ct. 418, 75 L.Ed. 1049. Its validity has been sustained by this court in Lamont v. Commissioner, supra; and by the 5th Circuit Court of Appeals in Sneed v. Commissioner, 5 Cir., 119 F.2d 767, and Crabb v. Commissioner, 5 Cir., 119 F.2d 772.

The contention that the regulation requires income in one year to be included in the income of a later year in which it was not received, thus cumulating income for a series of years, is erroneous. Depletion deductions are allowed on the theory that depletion represents the cost of a wasting capital asset. United States v. Ludey, 274 U.S. 295, 302, 47 S.Ct. 608, 71 L.Ed. 1054. When claimed and allowed depletion is treated and regarded as a reduction, or loss, of capital. When a mining lease is terminated without production the amounts allowed as deductions for such assumed capital losses resulting from advance payments in prior years may for the first time be regarded as income. Until then the depletion deduction is carried on the books of the taxpayer as a capital loss; and, as between the taxpayer and the Commissioner, it retains that status until it is determined upon expiration of the lease that the mineral paid for in advance was not removed from the mine. The status of the depletion deduction then, and not until then, changes from capital loss to income both on the books of the lessor-taxpayer and for tax purposes. This is the condition upon which the deduction is allowed. In the present case the same regulation being in effect during each year the lease was in effect, and in which year the deduction was claimed and allowed, the rule applies to the allowance in each year severally. While the total amount returned as income in 1937 corresponded to the aggregate amount of the deductions in...