Higgins Co. v. United States

• Decision Date: 04 January 1977
• Docket Number: Civ. No. 5-74-64 and 5-74-63.
• Parties: HIGGINS COMPANY, a Minnesota Corporation, Plaintiff, v. UNITED STATES of America, Defendant. DuNORD LAND COMPANY, a Minnesota Corporation, Plaintiff, v. UNITED STATES of America, Defendant.
• Court: U.S. District Court — District of Minnesota

444 F. Supp. 1

HIGGINS COMPANY, a Minnesota Corporation, Plaintiff, v. UNITED STATES of America, Defendant.

DuNORD LAND COMPANY, a Minnesota Corporation, Plaintiff, v. UNITED STATES of America, Defendant.

Civ. Nos. 5-74-64 and 5-74-63.

United States District Court, D. Minnesota, Fifth Division.

January 4, 1977.

Loren W. Sanford, Duluth, Minn., for plaintiffs.

Robert G. Renner, U. S. Atty., Minneapolis, Minn., Daniel J. Dinan, Atty., Dept. of Justice, Washington, D. C., for defendant.

ORDER

MILES W. LORD, District Judge.

These actions were brought separately and later consolidated. They involve an interpretation of Sections 631(c) and 272 of the Internal Revenue Code of 1954 as amended. The facts in each case are identical except for the amounts of the refunds claimed by each plaintiff company. In addition, plaintiff DuNord has filed refund claims for the tax years 1965-67 inclusive, whereas, the plaintiff Higgins has filed refund claims only for the years 1966 and 1967.

FACTS

The parties have submitted cross motions for summary judgment which are based upon the following stipulated facts:

1. Plaintiff is a Minnesota corporation, and its office and principal place of business is 417 First National Bank Building, Duluth, Minnesota.

2. The principal business activity of the Plaintiff is the ownership of interests in iron ore and other lands in the United States and the disposal of that iron ore to unrelated persons who mine the iron ore in the United States under a form of contract by virtue of which Plaintiff retains an economic interest in such iron ore, such that the amount of gain to be recognized from the disposal of such iron ore is to be determined by Section 631(c) of the Internal Revenue Code of 1954, as amended by Public Law 88-272, Section 227. An "unrelated person" is a corporation whose relationship to the Plaintiff would not deprive Plaintiff of the treatment of income provided by Section 631(c) of the Internal Revenue Code of 1954, as amended by Public Law 88-272, Section 227.

3. Minn.Stat., Chapter 290, imposed an income tax and an additional privilege and income tax on all domestic corporations for the taxable years in question.

4. (a) Pursuant to Minn.Stat., Chapter 290, Plaintiff paid to the State of Minnesota $7,556.36 in its taxable year ending May 31, 1966.

(b) During its taxable year ending May 31, 1966, Plaintiff received royalties in the amount of $72,720.55 under contracts of the type described in paragraph 2 for minerals located in Minnesota which it had held for at least six months. For that same year, Plaintiff's total gross income from all sources, including royalties, was $73,474.30. Due to proper deductions, Plaintiff has no taxable ordinary income for such year.

(c) Plaintiff timely filed its Federal income tax return for its taxable year ending May 31, 1966. In order to determine, under Internal Revenue Code, Section 631(c), the gain to be recognized upon the disposal of domestic iron ore held for more than six months and disposed of under a contract by virtue of which Plaintiff retained an economic interest in the iron ore in place, Plaintiff subtracted from its gross receipts derived from the disposal of such iron ore $7,478.53 of the Minnesota income taxes paid in that year. If it is determined that Minnesota income taxes paid are a deduction disallowed by Section 272 of the Internal Revenue Code of 1954, as amended by Public Law 88-272, Section 227, then this amount was correctly subtracted from Plaintiff's gross receipts derived from the disposal of iron ore.

(d) The Internal Revenue Service determined income taxes paid to the State of Minnesota to be an improper subtraction from gross receipts for the purpose of determining the gain from this disposal of iron ore, and notified Plaintiff on September 29, 1969, of an income tax deficiency for the taxable year ending May 31, 1966, in the amount of $1,856.47.

5. (a) Pursuant to Minn.Stat., Chapter 290, Plaintiff paid to the State of Minnesota $5,666.25 in its taxable year ending May 31, 1967.

(b) During its taxable year ending May 31, 1967, Plaintiff received royalties in the amount of $51,304.94 under contracts of the type described in paragraph 2 for minerals located in Minnesota which it had held for at least six months. For that same year, Plaintiff's total income from all sources, including royalties, was $53,643.21. Due to proper deductions, Plaintiff had no taxable ordinary income for the same year.

(c) Plaintiff timely filed its Federal income tax return for its taxable year ending May 31, 1967. In order to determine, under Internal Revenue Code, Section 631(c), the amount of gain to be recognized upon the disposal of domestic iron ore held for more than six months and disposed of under a contract by virtue of which Plaintiff retained an economic interest in the iron ore, Plaintiff subtracted from its gross receipts derived from the disposal of such iron ore $5,419.20 of the Minnesota income taxes paid in that year. If Minnesota income taxes are a deduction disallowed by Section 272 of the Internal Revenue Code of 1954, as amended by Public Law 88-272, Section 227, then this is the correct amount to be subtracted from gross receipts to determine the amount of gain to be recognized.

(d) The Internal Revenue Service determined income taxes paid to the State of Minnesota to be an improper subtraction from gross receipts for the purpose of determining gain from this disposal of iron ore, and notified Plaintiff on September 29, 1969, of an income tax deficiency for the taxable year ending May 31, 1967, of $1,354.80.

6. Plaintiff paid such deficiencies on December 15, 1969.

7. Plaintiff properly and timely filed a claim for refund of the taxes paid pursuant to the deficiency notices on December 14, 1971.

8. On July 14, 1972, the Internal Revenue Service disallowed in full Plaintiff's claims for a refund.

9. This civil suit for the recovery of Internal Revenue taxes alleged to have been erroneously or illegally assessed was timely filed.

10. This Court has jurisdiction of this matter. The venue of the matter is properly set in the District of Minnesota, Fifth Division.

11. The mineral properties subject to the contracts described in paragraph 2 under which Plaintiff received royalty income in the taxable years in question is property of the type subject to execution, sale and forfeiture under Minnesota law for failure to pay State of Minnesota income taxes.

12. Plaintiff's (lessor) contracts under which it retained an economic interest and which produced the iron ore royalty income described in paragraphs 4 and 5 contain lessor's covenants and warranties requiring protection of its title and ownership.

13. The Minnesota income tax subtracted by Plaintiff from gross royalty income, namely $7,478.53 and $5,419.20 in 1966 and 1967 respectively, is attributable solely to income derived from royalties under contracts of the type described in paragraph 2 above.

CONCLUSIONS OF LAW

As indicated by the stipulation of facts, the legal issue to be determined by the Court is whether the plaintiffs properly deducted their Minnesota income taxes from their gross royalty income derived from the disposal of iron ore. The resolution of this question is dependent upon an interpretation of the language contained in § 272 of the Internal Revenue Code of 1954 as amended (I.R.C.).

The plaintiff corporations own iron ore properties which they lease to either mining or steel companies. Their principal income is derived from royalties received as a result of these leases. Because of the fact that the product involved is iron ore and the fact that the plaintiffs have retained their interest in the iron ore for more than six months, they are eligible to treat their royalty income as a capital gain pursuant to § 631(c), I.R.C.¹ Under ordinary circumstances, the gain realized by the plaintiffs would not be treated as capital gain income. § 631(c) was adopted by Congress as a special tax preference in order to encourage the production of iron ore. See, Mertens, Code Commentary, § 272.1 (1975).

A companion provision to § 631(c) is § 272. § 272 provides as follows:

Where the disposal of coal or iron ore is covered by section 631, no deduction shall be allowed for expenditures attributable to the making and administering of the contract under which such disposition occurs and to the preservation of the economic interest retained under such contract, except that if in any taxable year such expenditures plus the adjusted depletion basis of the coal or iron ore disposed of in such taxable year exceed the amount realized under such contract, such excess, to the extent not availed of as a reduction of gain under section 1231, shall be a loss deductible under section 165(a). This section shall not apply to any taxable year during which there is no income under the contract.

Under this section if the disposal of iron ore is covered by § 631(c), no deduction against ordinary income shall be allowed for expenditures attributable to "the making and administering" of the iron ore contract or to the "preservation of the economic interest retained under such contract." If the expenditures are attributable to "the making and administering of the contract" or "to the preservation of the economic interest" retained under the contract, then they must be offset against the capital gain income computed under § 631(c) and cannot be deducted from ordinary income.

The problem presented in the instant case is that the plaintiffs had no ordinary income for the tax years in question. Their income consists entirely of royalty income from the disposal of iron ore which income is treated as a capital gain pursuant to § 631(c). Therefore, unless it is adjudged that Minnesota income taxes are expenditures attributable to the administering of the contract or to the preservation of the economic interest retained under the contract, the plaintiffs...