United States v. Morgan

• Decision Date: 09 August 1963
• Docket Number: No. 19840.,19840.
• Citation: 321 F.2d 781
• Parties: UNITED STATES of America, Appellant, v. J. A. MORGAN and Myra S. Morgan, Appellees.
• Court: U.S. Court of Appeals — Fifth Circuit

321 F.2d 781 (1963)

UNITED STATES of America, Appellant, v. J. A. MORGAN and Myra S. Morgan, Appellees.

No. 19840.

United States Court of Appeals Fifth Circuit.

August 9, 1963.

Lee A. Jackson, Atty., Dept. of Justice, Washington, D. C., Robert E. Hauberg, U. S. Atty., E. R. Holmes, Jr., Asst. U. S. Atty., Jackson, Miss., Louis F. Oberdorfer, Asst Atty. Gen., Meyer Rothwacks, Melva M. Graney, Robert L. Waters, Attys., Dept. of Justice, Washington, D. C., for appellant.

William E. Logan, Gulfport, Miss., Stanford E. Morse, Gulfport, Miss., W. E. Logan, Jr., Lafayette, La., for appellees.

Before RIVES and CAMERON, Circuit Judges, and BOOTLE, District Judge.

BOOTLE, District Judge.

J. A. Morgan, on December 23, 1953, obtained an oil and gas lease from Cora Suggs, et al., paying therefor Six Thousand ($6,000.00) Dollars. On July 24, 1954, for a cash consideration of Seventy-One Thousand Four Hundred ($71,400.00) Dollars, he did "sell, set over, transfer, assign and specially warrant unto E. A. Vaughey" the lease, and Vaughey the same day executed an assignment to Morgan of "one-sixteenth of * * * all oil, gas and other mineral as, if and when produced, saved and marketed * * until the said assignee (J. A. Morgan) herein * * * receives the sum of Ten Million and No/100 Dollars ($10,000,000.00) * * *." Under certain conditions "the fractional interest out of which said oil payment is to be made" was to be increased to one eighth, and said increase was later effectuated by all interested parties. The assignment or transfer provides that "there shall be no personal obligation on the part of the assignor (Vaughey) herein * * * for said sum ($10,000,000.00) or any part thereof."

On his 1954 income tax return, J. A. Morgan, hereinafter referred to as taxpayer,¹ treated the cash payment ($71,400.00, less the cost of the lease to him $6,000.00) as long-term capital gain. The Commissioner of Internal Revenue determined that the payment constituted ordinary income subject to depletion. Taxpayer paid the consequent deficiency plus interest and thereupon filed suit for refund under 28 U.S.C.A. § 1346(a) (1).

Taxpayer filed a motion and defendant a cross motion for summary judgment. In considering these motions, the district court had before it (1) the pleadings, (2) the taxpayer's claim for refund, which stated, among other things, that at the time of the alleged sale of the lease by him to Vaughey the nearest production to any land described in the lease was two miles away, and that the lease was "wild cat" until Vaughey drilled thereon months after the sale and encountered oil sands; that because taxpayer was strained financially, the large cash offer was the moving and controlling factor in the trade; that subsequent to the alleged sale the lease was drilled and production was encountered in several sands, and there are yet deeper sands to be tested in later years; that, therefore, it is not reasonable to say that the assigned oil payment will last for the life of the lease; that there are many things that can affect the time of pay-out from known production, and that had such an oil payment been carved out of the lease after it was in production, the position of the revenue agent might have been sound, but there was no reasonable basis for such conclusion as to a "wild cat" lease such as this where the substantial cash payment per se shows the intent of the vendor, (3) an affidavit by taxpayer setting forth generally his contentions, (4) the lease from Suggs to taxpayer, (5) the assignment or transfer of the lease by taxpayer to Vaughey, (6) assignment of alleged oil payment by Vaughey to taxpayer, (7) defendant's request for admission in which defendant requested taxpayer to "admit that at the time the oil payment of $10,000,000. was reserved by J. A. Morgan upon the assignment of an oil and gas lease to E. A. Vaughey that it was reasonable to assume that said oil payment could not be fully paid throughout the life of the lease," (8) taxpayer's response to said request for admission, as follows: "Plaintiffs * * * cannot truthfully admit or deny the matters of which an admission is requested by defendant because not a relevant matter as set out in affidavit of J. A. Morgan attached hereto", and said affidavit as follows: "Plaintiff, J. A. Morgan, states under oath that he cannot truthfully admit or deny whether or not it was reasonable to assume that at the time the oil payment of $10,000,000. was reserved to him that said oil payment could not be fully paid throughout the life of the lease for the reason that such an expression is a matter of opinion, and at best only a guess. Affiant is not qualified to express an opinion in this matter nor is anyone else qualified to do so," (9) affidavit of Gordon K. Smith, a petroleum engineer, to the effect that, based upon the facts known about the field in question, on July 24, 1954, it was his opinion "that the likelihood of the oil payment of $10,000,000. reserved by J. A. Morgan on the alleged assignment of a mineral base (sic) to E. A. Vaughey being completely paid out of one-eighth of production, was remote" and that in his opinion "a reasonable man would not expect that said oil payment would pay out prior to the termination of the base (sic) when the minerals are exhausted," and (10) an affidavit of counsel for defendant as follows: "Should the Court deny the motion to dismiss² filed by the defendant, we submit that an important question of fact remains in this case which has not been resolved by the pleadings nor the affidavit submitted by the plaintiffs in this action. The defendant is prepared to offer testimony at the time set for the hearing on the motion for summary judgment proving that the oil payment reserved by plaintiff J. A. Morgan upon the alleged assignment of a mineral lease to one E. A. Vaughey could not possible (sic) be expected to survive the extraction of the mineral from the land covered by the lease".

The district court overruled all of defendant's motions, granted taxpayer's motion for summary judgment and entered judgment accordingly. This appeal questions the correctness of the grant of that summary judgment.

This tax controversy relates only to the cash payment of the $71,400.00 received by taxpayer for his lease assignment or transfer. It relates to the nature of that item of income, whether it should be treated as ordinary income subject to depletion or as long-term capital gain. But the answer to that question turns upon the type of interest which taxpayer retained under his lease assignment or transfer. If taxpayer's reservation under his lease assignment or transfer was a royalty, then the cash payment is to be regarded as an advance royalty and taxed as ordinary income subject to depletion rather than capital gain; on the other hand, if taxpayer's reservation is a production payment, more commonly called an oil payment, then the cash payment is to be regarded as representing a conversion of capital by sale and taxed as long-term capital gain. The foregoing principles have been established by a few leading cases. In Palmer v. Bender, 287 U.S. 551, 53 S.Ct. 225, 77 L.Ed. 489 (1933), the Court was confronted with the question whether a taxpayer who, after acquiring oil and gas leases, executed writings in which he did "sell, assign, set over, transfer and deliver" unto another the described leased premises, thereby conferring upon such other person the right to take over the leased property on which a producing well was located, subject to the obligations of the covenants of the leases, in consideration of a present payment of a cash bonus, a future payment to be made out of one-half of the first oil produced and saved to the extent of a named sum, and an additional "excess royalty" of one-eighth of the oil produced and saved was entitled to a depletion allowance with respect to his income derived from the bonus payment and oil received under his contract with such other person. The government contended that taxpayer had assigned or sold his leases and hence was not entitled to any depletion allowance; taxpayer contended that the instruments he executed were not assignments but only subleases. The Court said "we do not think the distinction material." 287 U.S. 551, 555, 53 S.Ct. 225, 226, 77 L.Ed. 489. It referred to its earlier holding in Lynch v. Alworth-Stephens Co., 267 U.S. 364, 45 S.Ct. 274, 69 L.Ed. 660 (1925), to the effect that the allowance for depletion is not made dependent upon the particular legal form of the taxpayer's interest in the property to be depleted and that, regardless of the fact that the leases there under consideration did not convey title to the unextracted mineral deposits, they did confer upon the lessee taxpayer the exclusive possession of the deposits and the valuable right of removing and reducing the ore to ownership, thereby creating "a very real and substantial interest therein", and that the lessee taxpayer was entitled to a depletion allowance. In Palmer the shoe was on the other foot and the question was whether the lessor or transferor taxpayer was similarly entitled to depletion and the Court, coining the phrase "economic interest", held that a taxpayer has an economic interest in every case in which he has "acquired, by investment, any interest in the oil in place, and secures, by any form of legal relationship, income derived from the extraction of the oil, to which he must look for a return of his capital", and that the lessor or transferor taxpayer, having by the leasing transaction retained a right to share in the oil produced, had an economic interest in the oil in place which is depleted by production and that both the cash received at the time of the leasing transaction and the royalties are taxable as ordinary income subject to depletion.

Following Palmer, this Court has consistently held that amounts received upon the transfer of a lease, where the original lessee retains an...