Whitehead v. U.S.

• Decision Date: 18 July 1977
• Docket Number: No. 75-4253,75-4253
• Citation: 555 F.2d 1290
• Parties: 77-2 USTC P 9545 Robert WHITEHEAD and Clay J. Whitehead, Plaintiffs-Appellants, v. UNITED STATES of America, Defendant-Appellee.
• Court: U.S. Court of Appeals — Fifth Circuit

Page 1290

555 F.2d 1290

77-2 USTC P 9545

Robert WHITEHEAD and Clay J. Whitehead, Plaintiffs-Appellants, v. UNITED STATES of America, Defendant-Appellee.

No. 75-4253.

United States Court of Appeals Fifth Circuit.

July 18, 1977.

C. O. McMillan, Stephenville, Tex., for Robert Whitehead.

Frank B. Appleman, R. Gordon Appleman, Ft. Worth, Tex., for Clay J. Whitehead.

Frank D. McCown, U.S. Atty., Fort Worth, Tex., Scott P. Crampton, Asst. Atty. Gen., Tax Div., Grant W. Wiprud, Atty., Gilbert E. Andrews, Acting Chief, Appellate Section, U.S. Dept. of Justice, Washington, D.C., for defendant-appellee.

Appeals from the United States District Court for the Northern District of Texas.

Before GEWIN, RONEY and HILL, Circuit Judges.

GEWIN, Circuit Judge:

The issue in this case is whether certain transactions involving sand, gravel, and stone were sales or leases. Taking the view that the transactions were leases, the Internal Revenue Service ("the government") assessed additional taxes for the years 1969 and 1970. ¹ The taxpayers, Robert and Clay J. Whitehead, paid the deficiencies, unsuccessfully filed claims for refund, and then brought this suit for refund in the total amount of $12,148.33 plus statutory interest. On stipulated facts and cross motions for summary judgment, the district court entered judgment in favor of the government, and the taxpayers appealed. We reverse.

The dispute arises out of two contracts which purport to sell specified quantities of sand, gravel, and stone in place to Lone Star Cement Corporation for a specified price, with the buyer having successive options to purchase 50,000 cubic yard increments of the deposits. Both transactions are structured in the same way, one involving a tract in Parker County owned by the taxpayers and another involving a tract in Hood County owned by taxpayers and their mother. ²

The relevant stipulated facts can be summarized and the law discussed by reference to the Hood County tract. First the landowners granted the buyer an option to conduct tests to estimate the quantity of sand, gravel, and stone in place and to "purchase" 65 percent of the estimated deposits for fifteen cents per cubic yard. After conducting tests, the buyer exercised the option, "purchasing" 1,333,3331/3 cubic yards for a total price of $200,000. ³ By general warranty deed the landowners "conveyed" the purchased amount to the buyer but without specifying the location of the conveyed minerals within the tract.

The purchase price was payable $35,000 on closing and $35,000 on January 15, 1967, with the remaining balance of $130,000 payable in ten annual installments of $13,000 each beginning in November, 1968. The buyer paid the two $35,000 payments, as well as each annual payment of $13,000 prior to the stipulation of facts. The warranty deed retained a vendor's lien to secure the deferred payments. If in any contract year the purchaser removes and sells a quantity of material which when multiplied by fifteen cents per cubic yard exceeds the annual $13,000 payment, then the excess shall be paid to the sellers on the date of the next annual payment. Such additional payment must be applied to reduce the total $200,000 purchase price.

The buyer is not obligated to extract any material from the tract, and it had not done so when the facts were stipulated. When the buyer completely mines, removes, and sells 1,333,3331/3 cubic yards of sand, gravel, and stone from the tract, it has successive one year options to purchase an additional 50,000 cubic yards or more of the same material. Exercise of one option automatically creates another option for the same amount for the one-year beginning at the conclusion of the term during which the prior option was exercised. ⁴

The general principles for deciding this case are well established. The transaction constitutes a mineral lease and not a sale if the landowner retains an "economic interest" in the minerals subject to the agreement. Commissioner of Internal Revenue v. Southwest Exploration Company, 350 U.S. 308, 314, 76 S.Ct. 395, 398, 100 L.Ed. 347, 354 (1956). To have retained such an interest the taxpayer must have: (1) "acquired, by investment, any interest in the oil (or other mineral) in place," and (2) secured by legal relationship "income derived from the extraction of the (mineral), to which he must look for a return of his capital." Palmer v. Bender, 287 U.S. 551, 557, 53 S.Ct. 225, 226, 77 L.Ed. 489, 493 (1933). The Treasury Regulations contain this test. See 26 C.F.R. § 1.611-1(b)(1). In the instant case, as in most such cases, the existence of the first element is admitted, and our focus turns to the second.

Whether a taxpayer has tied his return to the extraction of minerals does not turn merely on the subtleties of draftsmanship, the formal attributes or descriptive terminology of an instrument, or local law. Commissioner of Internal Revenue v. P. G. Lake, Inc., 356 U.S. 260, 266-67, 78 S.Ct. 691, 695-97, 2 L.Ed.2d 743, 749 (1958); Palmer v. Bender, supra, 287 U.S. at 555-56, 53 S.Ct. at 226, 77 L.Ed. at 492. Rather, the nature of the transaction depends on economic realities. Rutledge v. United States, 428 F.2d 347, 352-53 (5th Cir. 1970); Wood v. United States, 377 F.2d 300, 310 (5th Cir.), cert. denied, 389 U.S. 977, 88 S.Ct. 465, 19 L.Ed.2d 472 (1967).

The taxpayers principally rely on Rhodes v. United States, 464 F.2d 1307 (5th Cir. 1972). In Rhodes the taxpayers conveyed all clay deposits under one acre for $7500. In addition, the grantee agreed to purchase all acres with clay deposits in the 23-acre tract, taking conveyance of at least 2 acres each year, for $7500 per acre. Tests previously had shown that there were clay deposits beneath all 23 acres. Since there was a transfer of all clay deposits in the 23-acre tract at a fixed price (23 times $7500), the transaction was held to be a sale.

Rhodes therefore well illustrates what we said in Vest v. Commissioner of Internal Revenue, 481 F.2d 238, 243 (5th Cir.), cert. denied, 414 U.S. 1092, 94 S.Ct. 722, 38 L.Ed.2d 549 (1973):

. . . (A) sale results where an agreement purports to transfer within a prescribed time period all, or a specific, predetermined quantity of minerals in place, in exchange for a fixed consideration. The economic effect of an agreement exhibiting these terms is abundantly clear. Not only does the transferor part completely with his interest in the minerals in place, he also acquires a right to receive payments which is not dependent upon extraction by the transferee. (citations and footnotes omitted).

It is immediately apparent that the taxpayers' transfer of 1,333,3331/3 cubic yards of minerals for $200,000 was a sale as described in Vest. The character of that sale for tax purposes, however, is complicated by the successive options also granted by taxpayers. ⁵ Consequently, Rhodes is not necessarily determinative here.

The government relies primarily on cases involving payments to transferors based on a percentage of the market value of minerals ⁶ extracted ⁷ or a fixed amount per cubic yard of minerals extracted, ⁸ sometimes with minimum payments required. In a sense these cases are relevant, because the method of payment in each suggested a "fixed price" for a sale of a "fixed amount," though the amount involved was a basic unit of measurement. Courts in these cases have found such transactions to be in the nature of mineral leases since the transferors received royalty payments tied to total extraction. But the government has not cited, nor have we found, a court of appeals or Supreme Court case holding that a sale of substantial mineral deposits at a fixed price is converted into a lease by options for further purchases.

The district court concluded that the instant transaction was a lease, reasoning that "(t)he only factor which is certain is that the taxpayers will receive a minimum guaranteed payment for 65% of the material, and 15 cents per cubic yard for the amount of remaining material Lone Star finds profitable to extract." In reaching this conclusion the court relied on its prior decision in Filgo v. United States, 387 F.Supp. 1300 (N.D.Tex.1974). In Filgo the taxpayers purported to "sell" 25,000 cubic yards of sand and gravel for $25,000 and also granted the buyer annual options to purchase additional increments of 25,000 cubic yards for $6,250 per increment. Significantly, the agreement contained a proviso that should the buyer estimate that less than 25,000 cubic yards remain in the tract, the buyer could purchase the remaining deposits for 25 cents per cubic yard. The court concluded that this agreement gave the buyer the right to mine sand and gravel from the tract to exhaustion over an indefinite period. Id. at 1304. ⁹

From Filgo and the cases relied on by the parties there is seen a continuum in mineral "sales," ranging from multiple "sales" of a basic unit of measurement (for example, one cubic yard of sand for 20 cents) to a sale of all the deposits of a certain mineral on a particular tract for a fixed price. Filgo and the instant case appear to be in between the two extremes.

The government seems to argue that a purported sale of minerals is a lease if it is possible that the same buyer could make additional purchases of the same mineral from the same tract. Logically extended, this means the government would contend that the sale of the 1,333,3331/3 cubic yards in the instant case is a lease without regard to the options, since it is possible that the taxpayers subsequently may sell the remaining sand, gravel, and stone to the buyer. Perhaps the government would stop short of this extension, arguing that it is the coincidence of the original sale and the granting of the options that is crucial. We fail to see the logic of this distinction. ¹⁰

We need not resolve all possible cases, and in particular we need not determine whether Filgo was properly decided. It was not appealed and is not before us. We...