Strother v. Commissioner of Internal Revenue, 3214

• Decision Date: 25 January 1932
• Docket Number: No. 3214,3215.,3214
• Citation: 55 F.2d 626
• Parties: STROTHER v. COMMISSIONER OF INTERNAL REVENUE. BANKERS' POCAHONTAS COAL CO. v. SAME.
• Court: U.S. Court of Appeals — Fourth Circuit

55 F.2d 626 (1932)

STROTHER v. COMMISSIONER OF INTERNAL REVENUE.

BANKERS' POCAHONTAS COAL CO. v. SAME.

Nos. 3214, 3215.

Circuit Court of Appeals, Fourth Circuit.

January 25, 1932.

Camden R. McAtee, of Washington, D. C., and Wells Goodykoontz, of Williamson, W. Va. (Mason, Spalding & McAtee, of Washington, D. C., and Goodykoontz & Slaven, of Williamson, W. Va., on the brief), for petitioners.

Andrew D. Sharpe, Sp. Asst. to Atty. Gen. (G. A. Youngquist, Asst. Atty. Gen., Sewall Key, Sp. Asst. to Atty. Gen., and C. M. Charest, Gen. Counsel, Bureau of Internal Revenue, and De Witt M. Evans, Sp. Atty., Bureau of Internal Revenue, both of Washington, D. C., on the brief), for respondent.

Before PARKER and SOPER, Circuit Judges, and BAKER, District Judge.

SOPER, Circuit Judge.

Bankers' Pocahontas Coal Company v. Commissioner, No. 3215.

The subject-matter of this suit involves income and profit taxes of the Bankers' Pocahontas Coal Company for the calendar years 1920-1926, as determined by the Board of Tax Appeals. Deficiencies in substantial amounts were charged against the taxpayer in each of these years; and a petition to review was filed. The Board made the following findings of fact with reference to the property concerned:

"In July, 1912, the Bankers' Pocahontas Coal Company, a West Virginia corporation, acquired the fee simple title to approximately 6,200 acres of coal lands, including both the surface and the mineral rights in the State of West Virginia. The land had no appreciable value except for the coal content.

"Upon incorporation in 1912, the corporation acquired by formal assignment and has continued to retain the beneficial interest of the original owners in certain contracts affecting the coal content which were executed in 1901 and 1902 with various operating companies and to which contracts the 6,200 acres and coal content were subject.

"These contracts were originally prepared by D. J. F. Strother, who at that time was attorney, director and stockholder in the predecessor corporations. The form of the contracts is that prevailing in the West Virginia coal fields, which followed the Pennsylvania form of contract as introduced by Pennsylvanians who were largely instrumental in the early coal development in the West Virginia field."

Each of these contracts purported to be a contract of lease between the prior owner of the land, as lessor, and a coal mining company, as lessee, covering a tract of land in McDowell county, W. Va. for a period of thirty years from January 1, 1901. It was provided that the lessee should have the sole and exclusive privilege of mining and coking coal on the premises, and of conducting a general mercantile business thereon. In consideration thereof, the lessee agreed to pay to the lessor, as rental for the premises, a royalty (ranging from 1 cent to 10 cents) for each ton of coal mined and sold or used for any other purpose than the manufacture of coke, and a larger amount for each ton of coke manufactured and sold upon the premises. In some cases, a minimum annual rental or royalty (ranging from $4,000 to $10,000) was agreed upon. In addition, the lessee agreed to pay all taxes assessed against the property, or the coal mined, coked, or manufactured. The lessee was given the option to renew the lease at its expiration; and provision was made for the final valuation and disposition of the improvements placed upon the land by the lessee.

The contention of the taxpayer is that these contracts, executed in the years 1901 and 1902, and acquired by it in the year 1912, were sales of coal in place that were fully complete before the Sixteenth Amendment went into effect, and that the royalties received during the period 1920 to 1926 were merely payments of obligations that existed unconditionally on March 1, 1913, and were not income taxable under the federal Revenue Acts. It is said that this construction of mining leases as sales of coal in place is the law of the state of West Virginia, laid down by its highest court, and is therefore a rule of property which the federal courts must respect and enforce. The Board of Tax Appeals, however, overruled this contention, and directed that the royalties should be included in the gross income of the taxpayer, subject to taxation.

The application of the income tax statutes passed in conformity with the Sixteenth Amendment to the proceeds of mining was first considered by the Supreme Court in Stanton v. Baltic Mining Co., 240 U. S. 103, 36 S. Ct. 278, 60 L. Ed. 546. The court held that a tax on the product of a mine is not, in its essence, a direct tax on property merely because some exhaustion of the ore body must result from the working of the mine, and that, even though an adequate allowance is not made for the depletion of the mineral, the tax does not become a direct tax on property because of its ownership. On the contrary, it was held in accordance with its former ruling in Stratton's Independence v. Howbert, 231 U. S. 399, 34 S. Ct. 136, 58 L. Ed. 285, that such a tax is a true excise levied on the business of carrying on mining operations. The Supreme Court reiterated and applied this rule in Von Baumbach v. Sargent Land Co., 242 U. S. 503, 37 S. Ct. 201, 205, 61 L. Ed. 460, where it was held that royalties from mining leases on lands in Minnesota constituted income subject to the Corporation Tax Law of 1909 (36 Stat. 11). It was pointed out that, under the law of Minnesota, such leases are not merely conveyances of the ore in place, and do not constitute a sale of any part of the land, but the ore derived from the operation of the mines constitutes rents and profits from the land. Commenting on this rule, the court said:

"Ordinarily, and as between private parties, there is no question of the duty of the Federal court to follow these decisions of the Minnesota Supreme Court, as a rule of real property long established by state decisions. Kuhn v. Fairmont Coal Co., 215 U. S. 349, 360, 30 S. Ct. 140, 54 L. Ed. 228, 234. Whether, in considering this Federal statute, we should be constrained to follow the established law of the state, as is contended by the government, we do not need to determine. The decisive question in this case is whether the payments made as so-called royalties amount to income so as to bring such payments within the scope of the Corporation Tax Act of 1909. The prior decisions of this court in Stratton's Independence v. Howbert, 231 U. S. 399, 34 S. Ct. 136, 58 L. Ed. 285, and Stanton v. Baltic Mining Co., 240 U. S. 103, 36 S. Ct. 278, 60 L. Ed. 546, in which the Stratton Case was followed and approved, are decisive of this question."

The court also held that there was no difference as to taxability of the gains from the mining operations, whether the ore was extracted by the mine owner, as in the Stratton Case, or by a lessee of the owner, as in the case of the Sargent Land Company.

All of this ground was considered by the Circuit Court of Appeals of the Third Circuit in Rosenberger v. McCaughn, 25 F.(2d) 699, a case which related to income taxes based on royalties or rents from coal lands in Pennsylvania. In that state, the courts apply a different rule from that in vogue in Minnesota, and hold that mining leases constitute sales of the mineral in place; and it was therefore argued that the case must be distinguished from the decisions of the Supreme Court we have cited. But it was held, and we think properly, that the rules of decision laid down by the state courts with regard to property, while generally controlling upon the federal courts, do not necessarily govern those courts in the interpretation of the laws of Congress in regard to taxation, and it was pointed out that in Von Baumbach v. Sargent Land Company, supra, the Supreme Court had reached the conclusion that royalties from mines constituted taxable income wholly aside from the construction placed by the Minnesota courts upon mining leases. The Supreme Court declined to review this interpretation of its decision when it denied certiorari. 278 U. S. 604, 49 S. Ct. 10, 73 L. Ed. 532. See, also, Hirschi v. United States, 67 Ct. Cl. 637, certiorari denied 280 U. S. 576, 50 S. Ct. 30, 74 L. Ed. 627; Berg v. Commissioner, 59 App. D. C. 86, 33 F.(2d) 641, certiorari denied 280 U. S. 598, 50 S. Ct. 69, 74 L. Ed. 644; Burkett v. Commissioner (C. C. A.) 31 F. (2d) 667, certiorari denied 280 U. S. 565, 50 S. Ct. 25, 74 L. Ed. 619; Alexander v. King (C. C. A.) 46 F.(2d) 235, 74 A. L. R. 174.

We shall assume, for the purposes of this decision, that the law of West Virginia, like that of Pennsylvania, is that a mining lease constitutes a sale of the mineral in place. It was said in National Coal Co. v. Overholt, 81 W. Va. 427, 434, 94 S. E. 735, that the English and many American decisions hold that when, in a mining lease, the parties contract with reference to a mineral known to exist, the quantity of which is unknown and incapable of exact ascertainment, and the lessee covenants to bring forth a minimum quantity annually, and to pay a minimum royalty, the contract amounts to a sale of the mineral in the land, and the lessee is bound to pay the minimum price. See, also, Feather v. Baird, 85 W. Va. 267, 102 S. E. 294; Urpman v. Lowther Oil Co., 53 W. Va. 501, 44 S. E. 433, 97 Am. St. Rep. 1027; Toothman v. Courtney, 62 W. Va. 167, 58 S. E. 915; Smith v. Root, 66 W. Va. 633, 66 S. E. 1005, 30 L. R. A. (N. S.) 176.

Nevertheless, we think that the royalties in question, subject to the deduction allowed by the Acts of Congress, constitute taxable income. There can be no doubt that it was the intention of Congress to tax them. It is provided in section 234 (a) of each of the pertinent statutes, to wit, the Revenue Act of 1918, 40 Stat. 1057, 1078, the Revenue Act of 1921, 42 Stat. 227, 256, the Revenue Act of 1924, 43 Stat. 253, 26 USCA § 986 (a), and the Revenue Act of 1926, 44 Stat. 9, 42 (26 USCA § 986 (a), that in computing the net...