Rutledge v. United States, 28432.

• Decision Date: 22 June 1970
• Docket Number: No. 28432.,28432.
• Citation: 428 F.2d 347
• Parties: James A. RUTLEDGE and Mattie L. Rutledge, Plaintiffs-Appellees, v. UNITED STATES of America, Defendant-Appellant.
• Court: U.S. Court of Appeals — Fifth Circuit

428 F.2d 347 (1970)

James A. RUTLEDGE and Mattie L. Rutledge, Plaintiffs-Appellees, v. UNITED STATES of America, Defendant-Appellant.

No. 28432.

United States Court of Appeals, Fifth Circuit.

June 22, 1970.

Donald E. Walter, U. S. Atty., Shreveport, La., John O. Jones, Tax. Division, U. S. Department of Justice, Fort Worth, Tex., Johnnie M. Walters, Asst. Atty. Gen., Meyer Rothwacks, David E. Carmack, Grant W. Wiprud, Attys., Tax Division, U. S. Dept. of Justice, Washington, D. C., for appellant.

Robert L. Curry, III, William D. Brown, Monroe, La., for appellees.

Before JOHN R. BROWN, Chief Judge, and AINSWORTH and GODBOLD, Circuit Judges.

AINSWORTH, Circuit Judge:

This case requires us to determine the proper tax treatment of income received by taxpayer¹ under contracts permitting the removal of sand and gravel from two tracts of taxpayer's land. As in Wood v. United States, 5 Cir., 1967, 377 F.2d 300, cert. denied, 389 U.S. 977, 88 S.Ct. 465, 19 L.Ed.2d 472 (1967), the issue presented here is whether the contracts were in essence sales of minerals in place or were mineral leases. If these were sales agreements, the payments received by taxpayer constituted proceeds from the sale of capital assets and were taxable as capital gain. On the other hand, if these were lease agreements, the payments were taxable as ordinary income subject to an allowance for depletion.

This is a tax refund suit brought by James A. Rutledge and his wife against the United States to recover income taxes and interest assessed against them and collected by the Commissioner of Internal Revenue in the amount of $27,805.86 for the taxable years 1963, 1964 and 1965. The case was tried to a jury, which answered special interrogatories in favor of taxpayer, and the District Court entered a judgment on the jury's verdict. At the end of taxpayer's case and then at the close of all the evidence, the Government moved for a directed verdict. Upon the entry of the judgment, the Government moved for a judgment notwithstanding the verdict or, alternatively, a new trial. All these motions were denied, and the Government appeals from the judgment and the order overruling its motion for a judgment n.o.v. or new trial.

As a matter of law, we conclude that the payments taxpayer received for the sand and gravel extracted from his land were correctly taxed as depletable ordinary income rather than as capital gain. Wood v. United States, 5 Cir., 1967, 377 F.2d 300, cert. denied, 389 U.S. 977, 88 S.Ct. 465, 19 L.Ed.2d 472 (1967). The judgment appealed from must therefore be reversed, and judgment entered in favor of the Government.

I.

Taxpayer owned a 328-acre tract in Ouachita Parish, Louisiana. On March 11, 1959, he executed a "lease" agreement on a standard form with C. O. Horton and R. T. Henry. This agreement entitled Horton and Henry, the "lessees," to remove sand and gravel from the 328-acre tract in consideration of (1) specified "royalty" payments to be made for each cubic yard of material removed and marketed and (2) payment of certain "advance royalties." The payments for each cubic yard removed and marketed were 15 cents for sand, 25 cents for pit-run gravel, and 35 cents for washed gravel. The monthly "advance royalty" was $200 for the first year and $416.66 for each subsequent year. The advance payments were to be offset against cubic yardage payments for materials removed, and yearly production was limited to the amount that would yield $25,000 in royalties payable to taxpayer. The "lease" was to be in effect for a term of ten years and so long thereafter as production continued. If operations did not yield at least $5,000 a year, however, by the mutual agreement of the parties the "lease" was to be automatically cancelled.

The Horton-Henry partnership proceeded to mine and remove sand and gravel from the 328-acre tract, and taxpayer was duly paid according to the terms of the "lease." The parties referred to the payments made to taxpayer as "rentals" or "royalties."

Subsequently, the "lease" was superseded by a "sale" agreement dated December 22, 1959, which purported to convey the 328-acre tract.² This agreement named taxpayer as the "vendor" of the tract and Ouachita Gravel Company (the corporate successor to the Horton-Henry partnership) as the "vendee." The consideration for the purported sale of the tract to the gravel company was stated to be (1) the same payments for each cubic yard of materials removed which had been provided for in the "lease" agreement and (2) the monthly advance payments that the "lease" had specified for the second and subsequent years.³ The instrument further provided that, if the gravel company failed to make any of the payments called for in the "consideration clause," the contract would be cancelled and the gravel company would be obligated "to immediately execute a reconveyance of all the property herein transferred, without cost," to taxpayer. In addition, it was agreed that the transfer of the tract would in any event terminate after twenty years, even if the gravel company had not removed all the sand and gravel from the tract before the termination date. The gravel company was granted an "easement or right-of-way" over the land purportedly conveyed. Taxpayer was to continue to pay ad valorem taxes on the land, and the gravel company was to pay all state severance taxes on the material removed. In a letter also dated December 22, 1959, taxpayer referred to the twenty-year limitation on production in the "sale" agreement and stated, "I now agree that such term shall be extended with the limitation as long as sand and gravel is mined and produced from the premises in commercial quantities." The gravel company was not obligated to remove any minimum amount of sand or gravel under the agreement, as amended.⁴

The gravel company mined the 328-acre tract, and taxpayer duly received the minimum advance payments and the cubic yardage payments.⁵ Taxpayer had nothing to do with the subsequent disposition of the sand and gravel after it had been extracted by the gravel company.

Taxpayer and his three brothers each owned an undivided one-fourth interest in an 80-acre tract situated immediately south of land owned by the Ouachita Gravel Company. In the spring of 1964, one of taxpayer's brothers negotiated an oral agreement with the gravel company regarding this tract. Under this agreement the gravel company was granted the right to extract sand and gravel from the tract in return for paying the moved. The gravel company was not re-brothers 30 cents for each cubic yard required to make minimum advance payments or to mine any minimum part of the 80 acres. The parties agreed that the gravel company would mine the tract in strips measuring 100 feet by 300 to 500 feet. Once the gravel company had removed the overburden from a strip, it was obligated to pay for all the merchantable sand and gravel in the strip. The agreement was terminable at the will of either party.⁶ The brothers terminated the agreement in 1967 after approximately 35 acres had been mined.

No determination was made of the size and extent of the sand and gravel deposits in either the 328-acre tract or the 80-acre tract before the agreements involving these tracts were executed.

In the District Court taxpayer contended that the payments he received from the gravel company during the years 1963-1965 were proceeds from the sale of capital assets held for more than six months. The Government responded that the payments were royalties paid under leases of the tracts containing the sand and gravel deposits. More specifically, the Government urged that, as a matter of law, taxpayer had retained an economic interest in the deposits under the leasing arrangements with the gravel company. Consequently, the Government moved for a directed verdict at the close of taxpayer's case in chief and again at the close of all the testimony. The District Judge, however, submitted the case to the jury on special interrogatories inquiring whether taxpayer had disposed of his entire economic interest in the two tracts and charged the jury regarding the criteria that should govern their verdict.

We conclude that taxpayer retained an "economic interest," Palmer v. Bender, 287 U.S. 551, 53 S.Ct. 225, 77 L.Ed. 489 (1933); Treas. Reg. § 1.611-1(b) (1), in the sand and gravel in place in the two tracts. Accordingly, we hold that the proceeds of the agreements with the gravel company were ordinary income to taxpayer, subject to an allowance for depletion. Wood v. United States, 5 Cir., 1967, 377 F.2d 300; United States v. Green, 5 Cir., 1967, 377 F.2d 550; United States v. Peeler, 5 Cir., 1967, 377 F. 2d 531. See also Royalton Stone Corporation v. Commissioner of Internal Revenue, 2 Cir., 1967, 379 F.2d 298; Laudenslager v. Commissioner of Internal Revenue, 3 Cir., 1962, 305 F.2d 686; Oliver v. United States, 4 Cir., 1969, 408 F.2d 769; Belknap v. United States, 6 Cir., 1969, 406 F.2d 737; Schreiber v. United States, 7 Cir., 1967, 382 F.2d 553; Rabiner v. Bacon, 8 Cir., 1967, 373 F.2d 537; Alkire v. Riddell, 9 Cir., 1968, 397 F.2d 779, United States v. White, 10 Cir., 1968, 401 F.2d 610 (en banc).

II.

The concept of "economic interest" upon which this case turns was so labeled by the Supreme Court in Palmer v. Bender, 287 U.S. 551, 53 S.Ct. 225, 77 L.Ed. 489 (1933). See generally Sneed, The Economic Interest — An Expanding Concept, 35 Texas L.Rev. 305, 309-316 (1957). In Palmer taxpayer was a lessee under an oil and gas lease who conveyed certain of his lease interests to a third party. The issue presented was whether taxpayer was entitled to an allowance for depletion on the consideration paid him by the third party. The Court held that he was entitled to depletion since he had retained by his stipulation for royalties with the third party "an economic interest in the oil and gas, in place, which is depleted by production." 287 U.S. at 557, 53 S.Ct. at 227. The...