Farmar v. United States

• Decision Date: 10 January 1983
• Docket Number: No. 15-80T,16-80T.,15-80T
• Parties: Philip D. FARMAR and Marian J. Farmar, and A. A. and Mary S. Sugg v. The UNITED STATES.
• Court: U.S. Claims Court

689 F.2d 1017

Philip D. FARMAR and Marian J. Farmar, and A. A. and Mary S. Sugg v. The UNITED STATES.

Nos. 15-80T, 16-80T.

United States Court of Claims.

September 22, 1982.

Certiorari Granted January 10, 1983.

William M. Linden, Houston, Tex., for plaintiffs. James A. Carter, attorney of record. Marvin K. Collie and Vinson & Elkins, Houston, Tex., of counsel.

Maxine C. Champion, Washington, D. C., with whom was Asst. Atty. Gen., John F. Murray, Washington, D. C., for defendant. Theodore D. Peyser, Jr., and Donald H. Olson, Washington, D. C., of counsel.

Before COWEN, Senior Judge, DAVIS and NICHOLS, Judges.

Certiorari Granted January 10, 1983. See 103 S.Ct. 722.

ON DEFENDANT'S MOTION FOR SUMMARY JUDGMENT AND PLAINTIFFS' CROSS-MOTION FOR SUMMARY JUDGMENT

DAVIS, Judge.

Plaintiffs, Philip D. and Marion J. Farmar, and A. A. and Mary S. Sugg, bring these consolidated refund suits to recover deficiencies assessed by the Internal Revenue Service (IRS or Service) for the taxable year 1976. Farmar and Sugg are owners of a mineral estate in lands located in Texas. They leased their ownership interests to two companies interested in oil and gas exploration. As compensation for the agreements they received lease bonuses, payable in several yearly installments; they were also to receive royalties as oil and gas was extracted from the land. The bonuses were payable no matter if oil or gas was ever produced.¹

In 1976, oil and gas was extracted and royalties were paid to the plaintiffs. They also received bonus payments that year. On their 1976 tax returns, they claimed a 22 percent percentage depletion deduction on both the royalty income and the bonus payments.

The IRS assessed deficiencies in federal income taxes for 1976 based on its disallowance of the percentage depletion deduction on the bonus income.² Taxpayers paid these deficiencies and filed claims for refunds. These were denied, leading to the present actions. Both parties have moved for summary judgment, and we agree that the basic facts are not in dispute. On those facts, we hold for the defendant.

I

For the year before us (1976), the relevant statutory tax provision is § 613A of the Internal Revenue Code, 26 U.S.C. § 613A (1976), which abolishes the percentage depletion allowance for oil and gas wells, restricting oil and gas developers to cost depletion.³ A limited exception is provided under § 613A(c) for small independent producers and royalty owners. (It is common ground that plaintiffs fall within that category). Subsection (c) provides that:

(c) Exemption for independent producers and royalty owners. —

(1) In general. — Except as provided in subsection (d), the allowance for depletion under section 611 shall be computed in accordance with section 613 with respect to —

(A) so much of the taxpayer's average daily production of domestic crude oil as does not exceed the taxpayer's depletable oil quantity; and

(B) so much of the taxpayer's average daily production of domestic natural gas as does not exceed the taxpayer's depletable natural gas quantity;

and the applicable percentage (determined in accordance with the table contained in paragraph (5)) shall be deemed to be specified in subsection (b) of section 613 for purposes of subsection (a) of that section.

26 U.S.C. § 613A(c)(1) (1976).⁴ Taxpayers covered by this subsection make their determination of gross income based on the pre-1975 rules of § 613, 26 U.S.C. § 613 (1976), and then apply the limitations and restrictions of § 613A for depletion on that income.

Plaintiffs' position is that § 613A retained the pre-existing system of depletion for independent producers and royalty owners, and merely established maximum limits on the amount of oil and gas subject to percentage depletion. They argue that the scheme for determining the amount and timing of depletion allowances on bonus payments, developed in the Supreme Court decisions of Burnet v. Harmel, 287 U.S. 103, 53 S.Ct. 74, 77 L.Ed. 199 (1932); Herring v. Commissioner, 293 U.S. 322, 55 S.Ct. 179, 79 L.Ed. 389 (1934); and, Douglas v. Commissioner, 322 U.S. 275, 64 S.Ct. 988, 88 L.Ed. 1271 (1944), is unchanged by the 1975 law. In their view, the bonus income is still subject to percentage depletion in the year it is received as long as there is oil or gas produced at some point during the life of the lease. (That was undoubtedly the pre-1975 law.) They say that bonus income can be converted to barrels per day (or cubic feet of gas) in the year of actual production,⁵ and at that time confined to the quantity limitations prescribed in § 613A. According to the taxpayers, this conversion reconciles § 613A and § 613 so that § 613A establishes only a quantity limitation and not a production precondition to application of the percentage depletion allowance.

The government, on the other hand, insists that under the new statute, (a) depletion must be tied to actual production in the taxable year (here, 1976); (b) lease bonuses (such as those in the current cases) are not depletable at all because they are not connected with actual production; and (c) the pre-1975 law, as interpreted by the Supreme Court, was changed to allow depletion (to independent owners and royalty owners) only with respect to payments dependent on actual production in the taxable year.

II

This difference is not an easy one to resolve, and neither the text of the statute nor its legislative history gives a resounding answer. There is already a judicial dispute over the correct approach. The full Tax Court, with one dissent, has come down on the government's side. Glass v. Commissioner, 76 T.C. 949 (1981) (lease bonuses), and Engle v. Commissioner, 76 T.C. 915 (1981) (advance royalties). Since we heard oral argument in the present cases, the Seventh Circuit has reversed the Tax Court's Engle ruling. Engle v. Commissioner, 677 F.2d 594 (7th Cir. 1982). That court held that a percentage depletion allowance is permissible with respect to advance royalties, whether or not actual production occurs in the year the deduction is taken. The court's theory strongly suggests, though the opinion does not hold, that the same rule applies to lease bonuses like those we have here.

In evaluating this troublesome problem for ourselves, we bear in mind some general canons for interpreting federal tax legislation. The traditional postulate is that ambiguities in statutory language should be resolved against the government. McFeely v. Commissioner, 296 U.S. 102, 103, 111, 56 S.Ct. 54, 58, 80 L.Ed. 83 (1935); Gould v. Gould, 245 U.S. 151, 153, 38 S.Ct. 53, 62 L.Ed. 211 (1917). However, a recognized exception, applicable to the present problem, is that provisions for deductions from income are to be strictly construed and applied in particular cases only if clearly provided for by the statutory language. Equitable Life Assurance Society v. Commissioner, 321 U.S. 560, 564-65, 64 S.Ct. 722, 724, 88 L.Ed. 927 (1944); White v. United States, 305 U.S. 281, 292, 59 S.Ct. 179, 184, 83 L.Ed. 172 (1938); Helvering v. Inter-Mountain Life Insurance Co., 294 U.S. 686, 689-90, 55 S.Ct. 572, 574-75, 79 L.Ed. 1227 (1935); Parker Pen Co. v. O'Day, 234 F.2d 607, 609 (7th Cir. 1956); cf. A. Crawford Greene v. United States, 145 Ct.Cl. 259, 268, 171 F.Supp. 459, 464, cert. denied, 360 U.S. 933, 79 S.Ct. 1451, 3 L.Ed.2d 1545 (1959). Deductions are a matter of legislative grace and a taxpayer has the burden of proving his entitlement to the income reduction. Interstate Transit Lines v. Commissioner, 319 U.S. 590, 593, 63 S.Ct. 1279, 1281, 87 L.Ed. 1607 (1943); Deputy v. DuPont, 308 U.S. 488, 493, 60 S.Ct. 363, 366, 84 L.Ed. 416 (1940); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440, 54 S.Ct. 788, 790, 78 L.Ed. 1348 (1934); cf. United States v. Stewart, 311 U.S. 60, 71, 61 S.Ct. 102, 109, 85 L.Ed. 40 (1940). More specifically for these cases, a taxpayer attempting to deduct a depletion allowance must establish that it is clearly allowed by legislation. Parsons v. Smith, 359 U.S. 215, 219, 79 S.Ct. 656, 660, 3 L.Ed.2d 747 (1959); Commissioner v. Southwest Exploration Co., 350 U.S. 308, 312, 76 S.Ct. 395, 397, 100 L.Ed. 837 (1956); Reinecke v. Spalding, 280 U.S. 227, 232-33, 50 S.Ct. 96, 97-98, 74 L.Ed. 385 (1930); South Jersey Sand Co. v. Commissioner, 267 F.2d 591, 593 (3d Cir. 1959); Jefferson & Clearfield Coal & Iron Co. v. United States, 83 Ct.Cl. 491, 494, 14 F.Supp. 918, 920, cert. denied, 299 U.S. 581, 57 S.Ct. 46, 81 L.Ed. 428 (1936). Ambiguities should be resolved against the taxpayer. Consolidated Chollar Gould & Savage Min. Co. v. Commissioner, 133 F.2d 440, 441 (9th Cir. 1943).

III

Though their meaning is not absolutely plain, the words of § 613A(c) suggest to us that Congress restricted percentage depletion to income derived from actual production during the taxable year, and did not merely establish a top limitation on the quantities of oil and gas subject to that kind of depletion.

It is clear, in the first place, that § 613A controls the allowance for percentage depletion (which is now limited to independent producers and royalty owners). Subsection (a) of § 613A provides (as its "general rule") that "Except as otherwise provided in this sectioni.e., § 613A, the allowance for depletion under section 611 with respect to any oil or gas well shall be computed without regard to section 613." emphasis added The question, then, is the method of calculation mandated by § 613A — not the method used when § 613 stood alone.

In turn, subsection (c) of § 613A (see Part I and footnote 4, supra), requires that the percentage oil and gas depletion allowance be computed "with respect to" "the taxpayer's average daily production" of domestic crude oil or natural gas. 26 U.S.C. § 613A(c)(1) (1976). The allowable depletable quantities are then defined in terms of production levels and the applicable depletion percentage rate and allowance is based on production during the particular taxable year. 26...