Yeaman v. U.S.

• Decision Date: 17 October 1978
• Docket Number: No. 76-2927,76-2927
• Citation: 584 F.2d 322
• Parties: 78-2 USTC P 9783 W. M. YEAMAN and Ramona Yeaman, Plaintiffs-Appellants, v. UNITED STATES of America, Defendant-Appellee.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 322

584 F.2d 322

78-2 USTC P 9783

W. M. YEAMAN and Ramona Yeaman, Plaintiffs-Appellants, v. UNITED STATES of America, Defendant-Appellee.

No. 76-2927.

United States Court of Appeals Ninth Circuit.

Oct. 17, 1978.

George Constable (argued), Seattle, Wash., for plaintiffs-appellants.

Ernest J. Brown, Atty. (argued), Dept. of Justice, Washington, D. C., for defendant-appellee.

Appeal from the United States District Court for the Eastern District of Washington.

Before DUNIWAY and CHOY, Circuit Judges, and GRANT, ^* District Judge.

GRANT, District Judge:

We are here presented with the question whether funds derived from oil and gas leases should be characterized as long-term capital gain from the sale of those leases, or as proceeds from the production of oil and considered ordinary income, subject to an allowance for depletion.

Plaintiffs filed a complaint claiming that they were entitled to refunds for the years 1970 and 1971, denied by the I.R.S. The district court determined that plaintiffs were not entitled to capital gain treatment concerning such proceeds and, consequently, were not entitled to the claimed refunds. We affirm.

This dispute stems from transactions occurring during the 1950's. In July 1951, the holder (A. G. Bailey Co., Ltd.) of an undivided 37.5 per cent interest in two oil and gas leases on property in the province of Alberta, Canada, entered into an agreement (entitled the "Buck Lake Participation Agreement") with an individual named R. M. Hardy, Sr., whereby Hardy acquired a 17.5 per cent interest in the undivided 37.5 per cent interest in the "net proceeds of production" from all subsequent drilling. In August 1951, Hardy entered into an agreement with Mr. Yeaman and a third party, whereby the three parties would share equally in the net proceeds of production as provided in Hardy's earlier agreement with the Bailey Company. At this point in time, Mr. Yeaman had a two per cent interest in the oil and gas leases (37.5% X 17.5% X 33.3%).

On 13 December 1954, Mr. Yeaman, Mr. Hardy, and the third party entered into an agreement, called an assignment, with the Crow's Nest Pass Coal Company. Under this agreement, Yeaman "assigned" his interest to Crow's Nest in consideration of his share of $149,222.66, plus 50 per cent of the future "net money profit" derived from his interest. The assignment defined the term "net money profit" as the "net proceeds of production" under the earlier Buck Lake Participation Agreement between the Bailey Company and Hardy. One month later, on 13 January 1955, the parties signed an "Agreement Amending Assignment", wherein it was provided that if the owner disposed of any lands relating to the oil and gas leases, the "Assignee shall promptly pay to the assignor one-half of all moneys received. . . . " The effect of this amended assignment is disputed by the parties and is the decisive issue in this case.

From 1954 through 1969, plaintiffs filed their income tax returns and reported the funds received from Crow's Nest as capital gains. In 1970 and 1971, plaintiffs received $61,421.36 and $69,974.26, respectively, as proceeds from the Crow's Nest assignment, and reported the funds as long-term gain from the sale or exchange of a capital asset. Upon audit, the I.R.S. determined that these amounts constituted income from mineral production, taxable as ordinary income, with an allowance for depletion, and assessed plaintiffs deficiencies. The deficiencies were paid, claims for refund were denied and a complaint was filed in the district court. The case was tried to a jury but the court granted the defendant's motion for a directed verdict. Thereafter, the plaintiffs instituted this appeal.

Plaintiffs argue that under the assignment to Crow's Nest, Mr. Yeaman made a sale of all his interest in the oil and gas leases and that he retained no economic interest therein; and that, therefore, plaintiffs are entitled to capital gains treatment on the funds received annually from Crow's Nest. In plaintiffs' opening brief, only one case is cited to support this contention, Helvering v. Elbe Oil Land Development Co., 303 U.S. 372, 58 S.Ct. 621, 82 L.Ed. 904 (1938) Reh. denied 303 U.S. 669, 58 S.Ct. 762, 82 L.Ed. 1125 (1938). It is claimed by plaintiffs that the facts of Elbe Oil are identical to those of the instant case. Without any further association to the case at bar, plaintiffs summarized the holding of Elbe Oil : That the transaction was an absolute sale of all properties, including the oil and gas in place, and the court was unable to conclude that a provision for additional payments qualified the effect of the transaction.

Furthermore, plaintiffs argue that while they had an economic interest in the contract with Crow's Nest, they had no right to the oil as such. This economic interest in the contract is explained as simply a "right to one-half of Crow's Nest's profits if any", without any right to drill wells on the property. (Appellants' brief p. 12.) Plaintiffs cite a General Counsel's Memorandum ¹ apparently to support the contention that in having only a right to the net profits of Crow's Nest, they retained no economic interest in the oil in place. In that General Counsel's Memorandum, the distinction is made between "a right to share in production, or the gross income therefrom, (which) is very different from the right to share in the net income of the producer (a right measured not by the production of mineral, as such, but by the degree of success in the operation of such a right owned by another)." It is further stated therein:

That rights to share in the oil produced are analogous to rights to share in gross proceeds derived from the sale of oil produced has been repeatedly stated by the highest Court. It would seem to follow that a right to a share of the proceeds from the sale of oil produced would give the payee ownership of a corresponding depletable economic interest without regard to conveyancing formalities . . . . For example, an instrument purporting to be a "lease" of oil or mineral lands, which gave a "lessee" a right to explore for and produce all the oil or mineral found thereon and required the lessee to pay the "lessor" Only a share of the net profits derived from the operation (as distinguished from a share of the product or the proceeds from the sale of the product), would leave the lessor without a depletable economic interest in the oil or mineral in place . . . ." (Emphasis added.)

p. 222. Plaintiffs argue that the assignment entitled them only to a share of the net profits derived from the operation.

Defendant maintains that the effect of the assignment to Crow's Nest was merely to transfer one-half of plaintiffs' interest in the proceeds of production from the oil leases, and that this constituted a retention of an economic interest. We agree. Palmer v. Bender, 287 U.S. 551, 53 S.Ct. 225, 77 L.Ed. 489 (1933) is the case which first defined an economic interest: "every case in which the taxpayer has (1) acquired, by investment, any interest in the oil in place, and (2) 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." 287 U.S. 551, 557, 53 S.Ct. 225, 226, 77 L.Ed. 489. The Court further held that the terminology of the instrument of transfer, whether it be in terms of a lease, assignment or sale, etc., is irrelevant. In Palmer, the Court found that the lessor of an oil lease had retained an economic interest and was, therefore, allowed to deduct a depletion allowance from the oil proceeds. Commissioner of Internal Revenue v. Southwest Expl. Co., 350 U.S. 308, 314, 76 S.Ct. 395, 100 L.Ed. 347 (1956).

There is no question of Mr. Yeaman's economic interest in the oil prior to the assignment. By the assignment to Crow's Nest, Mr. Yeaman did no more than transfer one-half of his interest, retaining 50 per...