Glass v. Comm'r of Internal Revenue

• Decision Date: 08 June 1981
• Docket Number: Docket No. 5169-79.
• Citation: 76 T.C. 949
• Parties: JAMES DAVID GLASS and WILLIE GLASS, PETITIONERS v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

76 T.C. 949

JAMES DAVID GLASS and WILLIE GLASS, PETITIONERS

v.COMMISSIONER of INTERNAL REVENUE, RESPONDENT

Docket No. 5169-79.

United States Tax Court

Filed June 8, 1981.

In 1975, petitioners received bonuses in the total amount of $139,940 upon the execution of several oil and gas leases. Producing oil or gas wells were completed during 1975 on all except one of the properties covered by the leases. The bonus received with respect to the lease on which no well was completed was $19,200. In addition to the bonuses, petitioners received royalties of $24,811 from the producing leases. Held, petitioners are not entitled to percentage depletion under sec. 613A(c), I.R.C. 1954, with respect to the lease bonuses. Guilford L. Jones III, for the petitioners.

John W. Dierker and Thomas G. Potts, for the respondent.

OPINION

FEATHERSTON , Judge:

Respondent determined a deficiency in the amount of $15,472.20 in petitioners' Federal income tax for 1975. The only issue for decision is whether petitioners are entitled to deduct percentage depletion under sections 611¹ and 613A with respect to certain oil and gas lease bonus payments which they received in 1975.

All of the facts have been stipulated.

Petitioners, who are husband and wife, filed a joint Federal income tax return for 1975 with the Internal Revenue Service Center, Austin, Tex. At the time the petition herein was filed, they were legal residents of Sterling City, Tex.

During 1975, petitioners executed certain oil and gas leases covering mineral interests in properties owned by one or both of them in fee simple. Upon the execution of each lease, petitioners received a bonus as consideration primarily for the right to explore for oil and gas on the leased properties and the right to produce, market, and retain the profits from such oil and gas, subject to the payment of a royalty to petitioners. The bonuses were received without reference to the actual production of oil or gas, and any royalties that might later accrue to petitioners could not be reduced because the bonuses had been received.

There was no production of oil or gas during 1975 from one of the properties covered by a lease executed in consideration of a bonus of $19,200. On the other properties covered by the leases, one or more wells were drilled and completed as producing oil or gas wells during 1975. With respect to these properties, petitioners received bonuses in the total amount of $120,740. They also received $24,811 in royalties on the production from these properties in 1975.

On their 1975 Federal income tax return, petitioners claimed deductions for percentage depletion with respect to the royalties they received on the production of oil and gas during that year and with respect to the bonuses they received upon the execution of the leases from which production was obtained. No deduction for depletion was claimed with respect to the bonus they received for the lease from which there was no production of oil or gas during 1975. In their petition, however, petitioners claimed an overpayment of taxes in the amount of $2,407 on the ground that they are entitled to a percentage depletion deduction in connection with the bonus received for the nonproducing lease. ²

In the statutory notice of deficiency, respondent allowed the deduction claimed by petitioners for percentage depletion with respect to the royalties received in 1975, but he disallowed in full the deduction claimed by them for percentage depletion on the lease bonuses.

Section 611(a) provides in part that “In the case of * * * oil and gas wells, [and] other natural deposits, * * * there shall be allowed as a deduction in computing taxable income a reasonable allowance for depletion.” In computing the deduction, a taxpayer may be entitled to use either of two different methods prescribed in the Internal Revenue Code—-cost depletion ³ or percentage depletion.⁴ Where the taxpayer is entitled to use either method, the method allowing the greater deduction for any given tax year must be used to compute depletion for that year. Secs. 1.611-1(a), 1.613-1, Income Tax Regs.

Prior to 1975, it was well-established law that the recipient of a lease bonus under an oil and gas lease could compute depletion on the basis of either the cost or the percentage method. See, e.g., Herring v. Commissioner, 293 U.S. 322 (1934). Effective for taxable years beginning after December 31, 1974, however, sections 613(d)⁵ and 613A (added by the Tax Reduction Act of 1975, Pub. L. 94-12, 89 Stat. 26 (Mar. 29, 1975)) deny the use of percentage depletion in the case of oil and gas wells, with certain limited exceptions.⁶ In this respect, section 613A(a) provides as follows:

SEC. 613A. LIMITATIONS ON PERCENTAGE DEPLETION IN CASE OF OIL AND GAS WELLS.

(a) GENERAL RULE .—-Except as otherwise provided in this section, the allowance for depletion under section 611 with respect to any oil or gas well shall be computed without regard to section 613 [i.e., without regard to percentage depletion.]

In contending that all of the oil and gas lease bonuses they received in 1975 are eligible for percentage depletion, petitioners appear to rely primarily upon section 613A(c), which sets forth a carefully circumscribed exception to the general rule of section 613A(a) for independent producers and royalty owners.⁷ Emphasizing the express language of section 613A(c), allowing percentage depletion only with respect to a limited quantity of a taxpayer's “average daily production” of oil or gas, respondent maintains that percentage depletion is not allowable on a lease bonus because it is not received with respect to the actual production of oil or gas. On that ground, respondent asks us to hold that petitioners are not entitled to percentage depletion on any of the bonuses received in 1975.

Consistent with our conclusion in Engle v. Commissioner, 76 T.C. 915 (1981), dealing with advance royalties, we hold that petitioners are not entitled to deduct percentage depletion with respect to their lease bonuses. Section 613A(c) allows percentage depletion deductions only for payments received with respect to actual oil or gas production. Because petitioners' lease bonuses were not received with respect to actual production during the taxable year, they do not qualify for percentage depletion. Under current law, lease bonuses are eligible only for cost depletion.⁸

Section 613A(c)⁹ provides, in part, that an allowance for percentage depletion under sections 611 and 613 shall be computed “with respect to * * * so much of the taxpayer's average daily production of domestic crude oil [and natural gas] as does not exceed the taxpayer's depletable oil [and natural gas] quantity.” The taxpayer's “average daily production” of oil or gas is to be determined by dividing his aggregate production of oil or gas “during the taxable year” by the number of days in the taxable year. The depletable oil quantity—-which the average daily production subject to percentage depletion may not exceed—-is computed by reference to a prescribed number of “barrels” of “production during the calendar year” reduced by the taxpayer's average daily secondary or tertiary production “for the taxable year.”¹⁰ The depletable natural gas quantity is defined to equal 6,000 “cubic feet”¹¹ of gas multiplied by the number of barrels of the taxpayer's depletable oil quantity that he elects to take into account for this purpose.

In attempting to apply section 613A(c) in accordance with the congressional intent underlying its enactment, we are not aided by any helpful legislative history. As indicated above, the section was added to the Internal Revenue Code by the Tax Reduction Act of 1975. As originally introduced, the bill leading to the act did not affect the percentage depletion allowance. A floor amendment was made in the House of Representatives that would have generally repealed the percentage depletion provisions for oil and gas. 121 Cong. Rec. 4651-4652 (1975). When the bill reached the Senate floor, the Senate added an amendment to provide a limited exemption from the repeal for independent producers and royalty owners. 121 Cong. Rec. 7813 (1975). The Senate amendment, altered to provide an even more limited exemption, became section 613A(c). The Conference report provides no guidance for the application of the statutory language in the circumstances here presented. See Conf. Rept. 94-120, 94th Cong., 1st Sess. (1975), 1975-1 C.B. 624, 629-630.

We are thus left only with the language employed by Congress in the Tax Reduction Act of 1975 as a guide to the congressional purpose in enacting the provisions concerning percentage depletion for oil and gas. The words by which “the legislature undertook to give expression to its wishes” are, however, usually the most “persuasive evidence” of the purpose and meaning of a statute. United States v. Amer. Trucking Ass'ns., 310 U.S. 534, 543 (1940); Gutierrez v. Commissioner, 53 T.C. 394, 400 (1969), affd. per order (D.C. Cir., Dec. 9, 1971). Unless the language of the statute is plainly at variance with some clearly defined legislative policy, we cannot look beyond the normal meaning of the words chosen by Congress. Busse v. Commissioner, 479 F.2d 1147, 1151-1153 (7th Cir. 1973), affg. 58 T.C. 389 (1972). We must examine petitioners' arguments in the light of these principles.

As we read section 613A(c), it does not permit percentage depletion with respect to an oil and gas lease bonus, and we find no legislative policy supporting petitioners' claims. Percentage depletion is allowable, in the words of the section, with respect to “so much of the taxpayer's average daily production” as does not exceed a specified depletable quantity. Under section 613A(c)(3), oil production is measured in “barrels,” defined to mean “42 United States gallons” (sec. 613A(e)(4)), and under section 613A(c)(4), natural gas production is measured in terms of “cubic feet.” In the oil and...