GROUP NO. ONE OIL CORPORATION v. Bass

• Decision Date: 19 February 1930
• Docket Number: No. 1176.,1176.
• Citation: GROUP NO. ONE OIL CORPORATION v. Bass, 38 F.2d 680, 8 AFTR 10 (W.D. Tex. 1930)
• Parties: GROUP NO. ONE OIL CORPORATION v. BASS, Collector of Internal Revenue.
• Court: U.S. District Court — Western District of Texas

8 AFTR 10, 38 F.2d 680 (1930)

GROUP NO. ONE OIL CORPORATION v. BASS, Collector of Internal Revenue.

No. 1176.

District Court, W. D. Texas, Austin Division.

February 19, 1930.

Baker, Botts, Parker & Garwood, of Houston, Tex., for plaintiff.

C. M. Charest, Gen. Counsel, Bureau of Internal Revenue, and Ottamar Hamele, Sp. Atty., Bureau of Internal Revenue, both of Washington, D. C., for defendant.

WEST, District Judge.

The submission of the case is on its merits, an agreed statement of facts, and waiver of jury. Plaintiff sues for refund of taxes as unlawfully collected because assessed on incomes received arising from instruments styled "Oil and Gas Leases" executed by the state of Texas, lessor, to the plaintiff, of certain described lands belonging to the state of Texas and the University of Texas, by the terms of which plaintiff acquired all of the oil and gas to be produced, the state to receive therefor a consideration in cash of an amount equal to the value of one-eighth of the gross quantity of oil produced, and an amount equal to the value of one-tenth of gas produced and sold. Plaintiff's net income from these two sources for the years 1925, 1926, 1927, and 1928 was taxed by the United States, and the amount $733,397.51 paid.

The questions presented are whether or not the net incomes realized by plaintiff lessee from oil and gas produced on lands belonging to the state and University of Texas are (1) exempt from taxation by the United States by the terms of the state annexation compact between the Republic of Texas and the United States, or (2) lawfully taxable by the terms of the Constitution of the United States.

Upon the close of the admission of evidence at the trial each party moved for judgment. The material facts being admitted, the disputed issues are those of law. The instruments are "Oil and Gas Leases," respectively, "No. 856" and "No. 8607," copies of which are attached to the original petition as Exhibits "A" and "B."

The truth of allegations of fact in plaintiff's original petition is conceded by stipulation, except immaterial matters in paragraph 9, and in other immaterial particulars.

The leases are executed by the state, through the Commissioner of the General Land Office, to plaintiff's assignors. Some of the provisions, in brief, are: "* * * Does hereby grant and lease * * *" for 10 years, with right to enter upon said land at all times during the life of the lease for the purpose of mining, drilling, and operating for petroleum or gas, to erect buildings, pipe lines, storage, on condition: "(1) The owner of the rights herein conveyed shall pay to the State of Texas * * * a sum of money equal to a royalty of one-eighth of the value of the gross production of petroleum and shall pay a sum of money equal to 10 per cent. of the value of all gas sold. * * * (2) The value of any unpaid royalty or royalties and any sum or sums due the State * * *" are a prior lien on all production. (3) Reasonable diligence is required in drilling and developing, with "bona fide effort to put out the produce of each producing well during the life of this lease, * * *" to drill offset wells. "(4) The owner of rights herein conveyed shall have the exclusive right * * *" to drill during the life of the lease and also right of way to lay pipe lines. (5) The owner of the lease, upon failure to perform enumerated requirements or to comply with any regulations adopted by the Commissioner of the General Land Office, will subject the lease to forfeiture. "(6) * * *. (7) * * *." (8) All terms and conditions shall extend "to the heirs, successors and assigns" of the lessee. The leases are signed by the Acting Commissioner of the General Land Office of Texas, with seal.

The lands leased first acquired status as property as being part of the domain of the King of Spain; then by succession passed to the Republic of Mexico; thence to the republic of Texas; and, finally, to the state of Texas and the University of Texas. The vacant and unappropriated lands of the republic were conceded by the United States, in the admission compact with the republic of Texas, as vested in the state of Texas, "to be disposed of as said State may direct."

Plaintiff's claims for refund are: That the lands leased were originally acquired and held by the republic of Texas in its sovereign capacity; and that by the treaty compact with the United States the right of the state of Texas to dispose of such lands was ceded without condition, other than that the United States should not be held for any debts or liabilities of the republic. Therefore, to tax the lands or the proceeds derived from their sale or lease would be to burden and hinder the state in the exercise of its treaty right to dispose of its lands as it might direct. Likewise a tax imposed on the incomes of plaintiff lessee derived therefrom, being the means and instrumentalities used by the State of Texas in the exercise of its unlimited right of disposal of its lands, would burden, impair, hinder, limit, and destroy such right.

The defendant contends: That only strictly governmental activities of a state are immune from federal taxation; that in this case neither the development of oil and gas by the State, nor the maintenance by the state of its university, are strictly governmental activities. Therefore, plaintiff's incomes, being profits made in disposing of oil purchased from the state, are subject to the federal tax assessed and collected.

The ability and industry of counsel have exhausted all sources of authority. The issues are narrowed to essentials. Stated in question form, they are:

First. What is the effect of the treaty guaranty on the right of the state of Texas to dispose of the lands of the republic of Texas?

Second. Are the so-called leases, and the plaintiff lessee-purchaser, the means and instrumentalities used by the state to develop its land for the state and its university?

Third. Is the maintenance by the state of its university a strictly governmental activity?

Fourth. Do the taxes on the incomes derived by plaintiff as lessee-purchaser of state lands, being the state's means and instrumentality, impair and abridge the state's right to dispose of its lands?

First question answered: The state of Texas came into being through resolutions of the Congress of the United States and the Convention of the Republic of Texas, the republic thus becoming a state. The resolutions are found in 5 U. S. Statutes 797; 9 U. S. Statutes 108; Gammel's Laws of Texas, vol. 2, pp. 1200, 1225, and 1228. The specific guarantee to the State is as follows:

"2. And be it further resolved, that the foregoing consent of Congress is given upon the following conditions, and with the following guarantees, to-wit:

"Second. Said State * * * shall also retain all the vacant and unappropriated lands lying within its limits, to be applied to the payment of the debts and liabilities of said Republic of Texas, and the residue of said lands, after discharging said debts and liabilities, to be disposed of as said State may direct; but in no event are said debts and liabilities to become a charge upon the Government of the United States."

No issue of fact is in the record to indicate the existence of any debts or liabilities of the republic of Texas. It is therefore assumed that the state is granted the right to dispose of its landed domain as it "may direct." The Legislature of the state, by mandate of the Constitution, was directed to establish and provide for the support and maintenance of the University of Texas. See state Constitution 1876, art. 7, §§ 10 to 15, inclusive. One million acres of land, in addition to previous grants, were set apart for the support of the university.

The Legislature passed laws concerning the disposal of the university lands. The act providing terms under which permits, leases, and sales could be made appeared in chapter 83 of Acts of the Thirty-Fifth Legislature, March 16, 1917, and is still effective. It applies to the methods used in this case.

Pursuant to the treaty grant, the state, through its fundamental law, directed that a million acres of land be set apart by the Legislature for the support of the university. They were so set apart. Acting through its Legislature, the state directed that the oil and gas underlying its university lands be developed by means of sales of oil in place, to be paid for only when reduced to possession by capture, or, in the words of the lease, when "produced." The right so to dispose of these essential elements of land through the means employed is included by the words of the treaty compact. There is no room for construction or interpretation of the words conferring unlimited right to dispose. They are clear and all embracing and should be given effect. The right being without limitation, none can be placed by the United States on the means and instrumentalities used by the state in disposing of its lands.

The court holds that the effect of the treaty compact is: That the state could dispose of its lands in the exercise of a strictly governmental activity or otherwise as it might direct; and therefore the United States has no power to impede or hinder the means and instrumentalities used by the state in exercising its unlimited right of disposal.

Second question answered: The method used by the state to develop the oil and gas on its university lands here being developed was to make the lease-purchase contracts with plaintiff, the incomes resulting therefrom to plaintiff being taxed, collected, and sued for herein. It is common knowledge that search for oil and gas is highly speculative. Oil drilling requires the employment of specialists, geologists, chemists, machinists, and the like. Oil when found must be "produced" at the well's mouth and sold there or at a distance, by transport in tank cars or pipe lines, to refineries, or to world markets. A state might embark in the business of producing oil,...