Murphy Oil Co v. Burnet

• Decision Date: 05 December 1932
• Docket Number: No. 80,80
• Citation: 53 S.Ct. 161,287 U.S. 299,77 L.Ed. 318
• Parties: MURPHY OIL CO. v. BURNET, Commissioner of Internal Revenue
• Court: U.S. Supreme Court

287 U.S. 299

53 S.Ct. 161

77 L.Ed. 318

MURPHY OIL CO.

v BURNET, Commissioner of Internal Revenue.

No. 80.

Argued Nov. 18, 1932.

Decided Dec. 5, 1932.

Messrs. Thomas R. Dempsey, of Los Angeles, Cal., and Randolph E. Paul, of Washington, D.C., for petitioner.

The Attorney General and Mr. G. A. Youngquist, Asst. Atty. Gen., for respondent.

Mr. Justice STONE delivered the opinion of the Court.

This case is here on certiorari, 286 U.S. 541, 52 S.Ct. 647, 76 L.Ed. 1279, to review a judgment of the Court of Appeals for the Ninth Circuit, 55 F.(2d) 17, which reversed an order of the Board of Tax Appeals, 15 B.T.A. 1195, and sustained a ruling of the Commissioner of Internal Revenue fixing the amount of depletion to be allowed and deducted from royalties received by petitioner in 1919 and 1920 as the lessor of oil lands, in determining petitioner's taxable income for those years.

In December, 1913, petitioner, the owner of two tracts of oil lands, leased them for stipulated net bonus payments, aggregating $5,173,595.18 and royalties of one-fourth of the oil produced by the lessee. All the bonus payments were made before 1919. Whether petitioner returned those payments as income or paid income tax on them for the years when received does not appear. During 1919 and 1920 petitioner received royalties from the leased lands. In returning its income for those years, it sought to deduct from the royalties received the entire original unit cost to it of the oil extracted during the taxable period, without any diminution by reason of the bonus payments which it had already received. Under the applicable Revenue Act of 1918, c. 18, 40 Stat. 1057, bonus and royalties received by the lessor of an oil lease, after deductions allowed by the taxing act, are taxable income of the lessor. See Burnet v. Harmel, 287 U.S. 103, 53 S.Ct. 74, 77 L.Ed. 199, decided November 7, 1932. The question to be decided is whether the Commissioner correctly calculated the deduction for depletion for the years in question, by treating the bonus previously received by the petitioner, as a return of capital and by reducing pro tanto the depletion allowed on the royalties received in later taxable years.

The court below sustained the Commissioner's treatment of the bonus payments as advanced royalties for which depletion must be allowed under section 234(a) (9), Revenue Act of 1918 (40 Stat. 1078), to the extent that they represent a return of capital, and held erroneous the conclusion of the Board of Tax Appeals that the entire bonus was taxable income. The correctness of this decision must first be determined, for, if the Board was right in ruling that the bonus was not subject to a depletion allowance, the method of computing the depletion to be allowed on the royalties received during the taxable years in question would present no problem. The taxpayer would be entitled to deduct the full capital investment per barrel in the oil extracted during those years.

Section 234(a)(9) of the 1918 act includes in the authorized deductions from gross income:

'(9) In the case of mines, oil and gas wells, * * * a reasonable allowance for depletion and for depreciation of improvements, according to the peculiar conditions in each case, based upon cost including cost of development not otherwise deducted: * * * Such reasonable allowance in all the above cases to be made under rules and regulations to be prescribed by the Commissioner with the approval of the Secretary. In the case of leases the deductions allowed by this paragraph shall be equitably apportioned between the lessor and lessee. * * *'

We think it no longer open to doubt that, when the execution of an oil and gas lease is followed by production of oil, the bonus and royalties paid to the lessor both involve at least some return of his capital investment in oil in the ground, for which a depletion allowance must be made under section 234. See Burnet v. Harmel, supra. This is obvious where royalties alone are insufficient to return the capital investment. A distinction between royalties and bonus, which would allow a depletion deduction on the former but tax the latter in full as income, when received, making no provision for a reasonably anticipated production of oil on the leased premises, would deny the 'reasonable allowance for depletion' which the statute provides. The harsh operation of such a rule with respect to taxpayers generally is apparent, and is emphasized by the opportunist character of petitioner's argument here. The rule for which it contends can operate to its advantage only if it fortuitously escapes payment of any tax on the bonus payments, which it insists shall be treated as income without the deduction of any depletion allowance.

Doubts, if any, whether the statute authorizes depletion of bonus payments, have been definitely set at rest by the repeated reenactment, without substantial change, of the provisions of § 234(a)(9)¹, since the promulgation of treasury regulations providing for such depletion.² See Burnet v. Thompson Oil & Gas Co., 283 U.S. 301, 307, 308, 51 S.Ct. 418, 75 L.Ed. 1049; Brewster v. Gage, 280 U.S. 327, 337, 50 S.Ct. 115, 74 L.Ed. 457; National Lead Co. v. United States, 252 U.S. 140, 146, 147, 40 S.Ct. 237, 64 L.Ed. 496.

The question remains whether the method followed by the Commissioner in this case in allocating depletion to bonus and royalties failed to afford that 'reasonable allowance' for depletion which the statute provides.

Article 215, Treasury Regulations 45 (1920 Ed.) provided:

'(a) Where a lessor receives a bonus or other sum in addition to royalties, such bonus or other sum shall be regarded as a return of capital to the lessor, but only to the extent of the capital remaining to be recovered through depletion by the lessor at the date of the lease. If the bonus exceeds the capital remaining to be recovered, the excess and all the royalties thereafter received will be income and not depletable. If the bonus is less than the capital remaining to be recovered by the lessor through depletion, the difference may be recovered through depletion deductions based on the royalties thereafter received. The bonus or other sum paid by the lessee for a lease made on or after March 1, 1913, will be his value for depletion as of date of acquisition.'

This paragraph of the regulation was amended, November 13, 1926, by Treasury Decision 3938, V-2, C.B. 117, to read as follows:

'(a) Where a lessor receives a bonus in addition to royalties, there shall be allowed as a depletion deduction in respect of the bonus an amount equal to that proportion of the cost or value of the property on the basic date which the amount of the bonus bears to the sum of the bonus and the royalties expected to be received. Such allowance shall be deducted from the amount remaining to be recovered by the lessor through depletion, and the remainder is recoverable through depletion deductions on the basis of royalties thereafter received.'

The important difference in operation between the regulation before its amendment and after is in the case where the Commissioner properly finds that the sum of the bonus and expected royalties exceeds the lessor's capital investment in the oil in the ground. If, for example, the bonus were $1,000,000 and the estimated royalties were $2,000,000 and the capital investment of the lessor in the oil in the ground, to be depleted, were $2,000,000 the allowed depletion for return of the capital investment would be deducted, one-third from the bonus and two-thirds from the royalties as received.

The regulation thus operates to distribute the lessor's anticipated profit or the taxable net income to be derived from the extraction of all the oil ratably between the bonus and royalties, so that the estimated profit element in each will be taxed as received, subject to such readjustments of capital account as are authorized by paragraphs (c) and (d) of the amended regulation, in the event of termination, abandonment, or expiration of the lease before all the oil is extracted. But, if the bonus and expected royalties together are not found to exceed the capital investment of the lessor, the entire bonus received in advance of royalties must be treated, after the amended regulation as well as before, as a return of capital, since, in that case, the expected royalties added to the bonus are, by hypothesis, sufficient to return no more than the lessor's capital.

Such was the case here. In determining petitioner's depletion allowance for the two years in question, the Commissioner made no specific determination of the 'expected royalties' from the leased lands. But such a determination was of consequence in allocating depletion to the bonus only in the event that the total of bonus and...