United States v. White, 9174.

• Decision Date: 30 September 1968
• Docket Number: No. 9174.,9174.
• Citation: 401 F.2d 610
• Parties: UNITED STATES of America, Appellant, v. Paul R. WHITE and Anna Lee White, Appellees.
• Court: U.S. Court of Appeals — Tenth Circuit

401 F.2d 610 (1968)

UNITED STATES of America, Appellant, v. Paul R. WHITE and Anna Lee White, Appellees.

No. 9174.

United States Court of Appeals Tenth Circuit.

September 30, 1968.

Grant W. Wiprud, Washington, D. C. (Mitchell Rogovin, Asst. Atty. Gen., Lee A. Jackson, Melva M. Graney, Jonathan S. Cohen, Attys., Dept. of Justice, Washington, D. C., Lawrence M. Henry, U. S. Atty., and David I. Shedroff, Asst. U. S. Atty., of counsel, with him on the brief), for appellant.

Stanley L. Drexler, Denver, Colo. (Ellis J. Sobol, Denver, Colo., with him on the brief), for appellees.

Before MURRAH, Chief Judge, and LEWIS, BREITENSTEIN, HILL, SETH, and HICKEY, Circuit Judges.

SETH, Circuit Judge.

This is an action for refund of federal income taxes paid for the calendar years 1959 through 1962, in the amount of $73,600.96. We considered a portion of this same transaction involving the same taxpayers in United States v. White, 311 F.2d 399 (10th Cir. 1962).

The primary issue on appeal concerns the correctness of the trial court's conclusion that certain royalty payments were taxable as long term capital gain rather than as ordinary income subject to depletion.

The record shows that uranium was discovered on the taxpayers' fee land in 1953, and they leased it to an individual. The lessee was unable to fully develop the property, and it was concluded that the minerals, together with the mineral lease, should be transferred to Denver-Golden Oil and Uranium Company. Taxpayers so transferred their mineral interest by a mineral deed, which contained the usual warranties of title, and was in the form of an absolute conveyance of the minerals except coal, oil and gas. This deed, however, retained a royalty to the grantors-taxpayers, but did not require the grantee to develop the property. The taxpayers retained no reversionary rights. The provision as to the royalty reserved to taxpayers reads as follows:

"* * * a royalty of ten per centum (10%) of the gross value of all minerals mined, marketed and sold from the premises, said gross value being determined by payments received for all ores including bonuses and freight allowances but after deduction of actual costs of milling, smelting, treatment, cost of transporting the ores, and imposition of penalties of sic any; * * *."

As initial consideration for their transfer, taxpayers received a lump sum payment of $175,000. Taxpayers' mineral lessee assigned his lease outright to Denver-Golden for a lump sum consideration, and retained no royalty.

At the time the minerals were conveyed by taxpayers, some underground development had been done. This included some drifts and tunnel work, some diamond drilling, and trenching. Up to this time about 1200 tons of ore worth about $65,000, with the bonus payments, had been sold. There appears in the record a detailed report by a geologist who had been connected with the property for some time. This report was submitted to the purchaser about a month before the date of the mineral deed. This report describes in detail the existing workings, the geology of the tract, and the several mineralized veins. The geologist describes the quantity of ore and per cent of mineralization in each of the several areas, and estimates the total of inferred and indicated ore. He then gives the total net value of such ore (after mining and development costs and a ten per cent royalty) at about $1,631,000, and expresses his opinion that the potential may be much greater.

This court in United States v. White, 311 F.2d 399 (10th Cir.), considered the federal income taxes applicable to the lump sum initial payment to these same taxpayers. We there said: "* * * there was a sale of the minerals, and that the $175,000 payment as part of the consideration therefor, was properly treated as a capital gain for income tax purposes * * *." The court stated that the taxpayers "* * * retained no investment or interest, economic or otherwise, in the minerals in place. The purchaser was free to remove the minerals, or not, as it saw fit." We also there stated: "We do not reach the question of whether the payments to be made from production amount to the reservation of an economic interest which would require a different tax treatment of the income from that source." We have now reached this question, and not only find it difficult to answer but also conclude that to answer it in accordance with the prevailing authorities, we must overrule United States v. White, supra. As will be hereinafter developed the transaction must be examined as a whole and, under the decisions of the Supreme Court, put into one category. It is tempting to divide the transaction into several steps with different tax consequences, but this cannot be done. The tax category into which the entire transaction must be placed is that of a lease. Under the authorities this characterization rightly or wrongly usually disposes of the regular income-capital gains issue. The court has decided that in overruling United States v. White, it must for the sake of consistency in treatment be guided by the extensive case law developed in the oil and gas field.

The trial court in view of our previous decision in United States v. White held that the royalty reservation was a "deferred payment provision" and was "additional consideration over and above the lump sum payment which was at the time of the execution of the deed promised by the grantees in connection with the purchase by them of the mineral." Thus it afforded capital gains treatment on the royalty.

Our opinion in the previous case refers to several Circuit Court and Tax Court cases. These cases are primarily concerned with minerals other than oil and gas, and are cases in which the doctrines developed in the oil and gas cases concerning assignments with retained interests are not followed. In these cases the courts, in departing from the oil and gas authorities, have held that the "intent" of the parties leads to a sale conclusion, or that the "dominant purpose" of the transaction, or the "true substance" of the assignments lead to such a departure. Also these cases include instances where the "royalty" payment is on a unit basis unrelated to value of the substance to be removed. These cases include: Barker v. Comm'r of Internal Revenue, 250 F.2d 195 (2d Cir.); Crowell Land & Mineral Corp. v. Comm'r of Internal Revenue, 242 F.2d 864 (5th Cir.); Ima Mines, 32 T.C. 1360; Comm'r of Internal Revenue v. Remer, 260 F.2d 337 (8th Cir.); Linehan v. Comm'r of Internal Revenue, 297 F.2d 276 (1st Cir.); Griffith v. United States, 180 F.Supp. 454 (Wyo.1960); Jeanette Ord Sager, 21 CCH Tax Ct. Mem. 641 (1962); see also United States v. Witte, 306 F.2d 81 (5th Cir.).

In the above cases it is apparent that the courts have avoided the application of the oil and gas cases, or there were present factors making the unit payments something other than royalty. The emphasis has been placed instead upon the intention of the parties, as indicated above, and upon other factors in the particular transactions. As will be hereinafter discussed, there is however no real basis for making a distinction grounded on the nature of the hard mineral transactions as compared to those involving oil and gas. The position of the parties in most of the mineral cases is probably not influenced greatly by the difference in the amount of statutory percentage depletion although the comparatively low rate in the sand and gravel cases may be of some influence.

It is safe to say that the courts which have considered oil assignments or conveyances of oil and gas leases with an ordinary royalty retained by the transferor have uniformly held that the transferor has retained an economic interest, and the royalty income is ordinary income subject to the depletion allowance. Thus it is reasonable to assume that if the transaction before us was an absolute assignment of oil and gas lease, the overwhelming weight of authority would be that the royalty was ordinary income.

The Supreme Court has considered primarily the oil and gas cases which involve the question as to which of the parties is entitled to the depletion allowance, and thus what constitutes an "economic interest."¹ In Palmer v. Bender, 287 U.S. 551, 53 S.Ct. 79, 77 L.Ed. 512, the Court held that a taxpayer had to have an "economic interest" in the oil and gas before he was entitled to the depletion allowance on proceeds received from its sale. Much subsequent litigation has been concerned with trying to define an "economic interest" because the Court has said in effect that if the transferor retained an economic interest, he was entitled to depletion and also that the transaction was not a sale but a lease.

In Burnet v. Harmel, 287 U.S. 103, 53 S.Ct. 74, 77 L.Ed. 199, the issue was whether a bonus payment paid the lessor upon an oil and gas lease, which reserved the usual royalty, was to be treated as capital gain or ordinary income. The Circuit Court had said that under local law the title to the minerals passed upon delivery of the lease and thus the bonus was consideration for a sale. The Supreme Court...