Filgo v. United States, Civ. A. No. CA 3-6507-E.

• Citation: 387 F. Supp. 1300
• Decision Date: 17 July 1974
• Docket Number: Civ. A. No. CA 3-6507-E.
• Parties: Lee R. FILGO and wife Thelma Filgo v. UNITED STATES of America.
• Court: U.S. District Court — Northern District of Texas

387 F. Supp. 1300

Lee R. FILGO and wife Thelma Filgo v. UNITED STATES of America.

Civ. A. No. CA 3-6507-E.

United States District Court, N. D. Texas, Dallas Division.

July 17, 1974.

John L. Burke, Jr., Dallas, Tex., for plaintiffs.

Frank D. McCown, U. S. Atty., Fort Worth, Tex., Martha Joe Stroud, Asst. U. S. Atty., Michael D. Cropper, Tax Div., Dept. of Justice, Dallas, Tex., for defendant.

MEMORANDUM OPINION

MAHON, District Judge.

This is a suit brought for refund of federal income taxes in the amount of $16,662.43 plus interest of $1,003.57 for the taxable years 1968, 1969, and 1970. During those years, sand, gravel, and fill dirt were extracted from the plaintiffs' 168-acre farm. They urge that the proceeds are payments for the sale of capital assets and that for tax purposes they are entitled to the treatment accorded capital gains. Int.Rev.Code of 1954, § 1201(b), 26 U.S.C. § 1201(b) (1970).

Plaintiffs Lee and Thelma Filgo entered into an agreement with Texas Industries, Inc., in March of 1968 under which, according to the terms of the contract, plaintiffs did "Grant, Bargain, Sell and Convey unto Texas Industries 25,000 cubic yards of sand and gravel. . . ." for which they were paid $25,000.00. Included in the agreement was a provision whereby Texas Industries, Inc., received "exclusive irrevocable options to purchase . . . all or any part of the sand and gravel contained in, on, and under the land . . . in as many increments of 25,000 cubic yards of sand and gravel as Grantee shall elect for a consideration of $6,250.00 per increment; provided, however, should Grantee estimate that less than 25,000 cubic yards of sand and gravel remains in said land, Grantee may purchase an increment equal to such lesser amount at the rate of $0.25 per cubic yard thereof." The agreement allowed for the exercise of option rights at any time during the initial one-year term. The exercise of such rights to purchase one or more increments during any given year would result in there being an extension of the term for an additional year commencing at the conclusion of the term in which it had been exercised. A similar contract was drawn with regard to fill dirt which was conveyed in lots of 100,000 cubic yards. In addition to the original conveyances of sand and gravel and of fill dirt, Texas Industries received four subsequent increments of sand and gravel and nine increments of fill dirt pursuant to the option provisions during the years in question.

Defendant claims "that the transfers of fill dirt and sand and gravel by Mr. Filgo were made pursuant to what is, in effect, a mineral lease; that Mr. Filgo retained an economic interest in the sand and gravel and fill dirt in place; and that the income from the transfers of fill dirt and sand and gravel was ordinary income from mineral production." In the alternative, the government contends that if the transactions in question were sales, they were sales of property held by the taxpayer primarily for sale to customers in the ordinary course of trade or business, for which capital gains treatment would not be available. Int.Rev.Code of 1954 § 1221, 26 U.S.C. § 1221 (1970).

In the cause at bar considerable emphasis has been placed upon the "economic-interest" concept enunciated in Palmer v. Bender, 287 U.S. 551, 53 S.Ct. 225, 77 L.Ed. 489 (1933),¹ which in most instances is the test that is determinative of the right to an allowance for depletion with regard to the extraction of minerals. In Palmer the Supreme Court said that an economic interest exists in "at least . . . every case in which the taxpayer has acquired, by investment, any interest in the oil in place, and secures, by any form of legal relationship, income derived from the extraction of the oil, to which he must look for a return of his capital." 287 U.S. at 557, 53 S.Ct. at 226. This test has been adopted by the Treasury Department and is applicable to solid minerals including sand and gravel, and fill dirt. Treas.Reg. § 1.611-1(b)(1) (1960); 26 C.F.R. § 1.611-1(b)(1) (1973); Wood v. United States, 377 F.2d 300 (5th Cir. 1967), cert. denied, 389 U.S. 977, 88 S. Ct. 465, 19 L.Ed.2d 472 (1967).

It has been said that the term "economic-interest" "plagues the tax consequences of every assignment of property in all extractive industries . . .,"² and Professor Sneed³ writes:

"An understanding of this concept is the bedrock upon which any reasonably thorough appreciation of mineral tax law must be built. Grasp the economic-interest notion and many arcane aspects of this highly glamerous field will stand revealed."⁴

While the above-stated definition of the term "economic-interest" seems relatively clean and concise, the decisions relative to the concept reflect that it should be approached guardedly. The Fifth Circuit Court of Appeals has made mention of the "subtleties and intricacies of the economic interest test,"⁵ and one authority refers to the concept as "mystifying and somewhat illusory."⁶ Mr. Justice Frankfurter wrote of the "over-nice distinctions" in this area of the law as "gossamer lines . . . which hardly can be held in the mind longer than it takes to state them. . . ."⁷ In short, the expression "economic-interest" is, in many ways, deceptive in its appearance of simplicity.

Having examined those cases in which the economic interest test has been construed,⁸ including a considerable number of decisions by the Court of Appeals for the Fifth Circuit,⁹ this Court expresses its qualified agreement with the statement of the Government in its brief wherein it is said:

"The issue presented here is whether the contract was in essence a sale of minerals in place or a mineral lease. If a sale, as contended by tax-payers, the payments they received constituted proceeds from the sale of a capital asset and were taxable as capital gain. If the transaction was a lease agreement, as contended by the Commissioner of Internal Revenue, the payments were taxable as ordinary income subject to an allowance for depletion."

The Government's recitation of "the issue presented" may appear to be a statement of the obvious. As noted above, however, the Court's accord is not unconditional. While the resolution of the "lease-sale" dichotomy and the answering of the question whether an economic interest has been retained may in some measure be implicit in each other, they are not identical. Determining the nature of the agreement that is the subject of inquiry does not necessarily determine whether an economic interest has been retained by the taxpayer. Vest v. Commissioner of Internal Revenue, 481 F.2d 238, 244 (5th Cir. 1973).

The taxpayer urges that several separate independent bona fide sales are before the Court and that they should be viewed as unrelated occurrences for tax purposes. In this regard the Court notes that a specific quantity could be segregated from a mineral interest and could be isolated for the purpose of sale.¹⁰ Further, there appears to be no reason why an owner of property would be necessarily precluded from making disposition thereof through a multiple of transactions. The Government would place itself in an untenable position were it to claim that a property owner could engage in but one sale or that a given purchaser could buy no less than the whole. Nor does it seem there would be any reason why an owner of an interest in land could not avail himself of a series of conveyances to a particular transferee to divest himself of his interest.¹¹

It is, however, axiomatic that the substance of a contract's terms will prevail over its form and that an analysis of its provisions and the related facts may be appropriate in determining the "essential character" of a transaction. Vest v. Commissioner of Internal Revenue, 481 F.2d 238, 242, 243 (5th Cir. 1973); Rhodes v. United States, 464 F. 2d 1307, 1311 n. 4 (5th Cir. 1972); Rutledge v. United States, 428 F.2d 347, 352 (5th Cir. 1970). Each case must be decided on its own facts, Estate of Walker v. Commissioner of Internal Revenue, 464 F.2d 75, 77 (3rd Cir. 1972); Wood v. United States, 377 F.2d 300 (5th Cir. 1967), and the use of word of "sale" will not necessarily be controlling. Vest v. Commissioner of Internal Revenue, 481 F.2d 238, 243 (5th Cir. 1973); Rutledge v. United States, 428 F.2d 347, 352 (5th Cir. 1970); Hartman Tobacco Co. v. United States, 471 F.2d 1327, 1329 (2d Cir. 1973).

Parties may enter into any agreement they want, even if the particular terms are chosen for the purposes of reducing taxes. Cowden v. Commissioner of Internal Revenue, 289 F.2d 20, 23 (5th Cir. 1961); Gregory v. Helvering, 293 U.S. 465, 469, 55 S.Ct. 266, 267, 79 L.Ed. 596, 599 (1935). However, it is to be observed that that part of the Internal Revenue Code providing for capital gains "has always been narrowly construed so as to protect the revenue against artful devices." Commissioner of Internal Revenue v. P. G. Lake, 356 U.S. 260, 265, 78 S.Ct. 691, 694, 2 L.Ed. 2d 743, 748 (1958). Further, the taxpayer shoulders the burden of establishing that he qualifies for capital gain treatment. Hair v. Commissioner of Internal Revenue, 396 F.2d 6, 8 (9th Cir. 1968); Schreiber v. United States, 382 F.2d 553 (7th Cir. 1967).

It is in this context that the Court believes that the option clause in the agreement between Filgo and Texas Industries is of cardinal importance, for it is that provision which gives Texas Industries what is in reality the right to mine the sand and gravel from the Filgo property to exhaustion over an indefinite period of time. Further, the Court finds it extremely difficult to ignore that the taxpayer has an interest in the development of the mineral estate and that the amount of income he realizes from his arrangement with Texas Industries is almost entirely dependent upon the quantity of sand, gravel, and fill dirt Texas Industries mines.¹² In a real sense no specific predetermined quantity of minerals was to be mined, no total price...