In computing the excise, under the Corporation Tax Act of August
5, 1909, of a mining Company operating under a lease terminable at
its option in any year and which grants it the privilege of
entering, and of exploring for, mining and removing ores, in return
for a royalty of so much per ton removed, but which does not convey
the ore
in situ, that part of the value of the ore
disposed of during the tax .year which represents its value as ore
in place when the law took effect should not be deducted as
depreciation of capital assets.
Von Baumbach v. Sargent Land
Co., 242 U. S. 503.
The lease here involved is not to be construed as a conveyance
of the ore in place, although the latter could be measured with
substantial accuracy.
242 F. 9 reversed.
The case is stated in the opinion.
Page 247 U. S. 118
MR. JUSTICE DAY delivered the opinion of the Court.
This case is here upon a writ of certiorari to the United States
Circuit Court of Appeals for the Sixth Circuit. It was instituted
by the United States in the District Court of the United States for
the Northern District of Ohio to recover the sum of $2,653.72,
being 1% upon $265,372.08, which, it was claimed, the mining
company had wrongfully omitted from the return of its net income
for the year 1910 under the Corporation Tax Act of 1909.
The case was tried upon an agreed statement of facts which,
omitting unnecessary details, were epitomized by the district court
as follows:
"In the year 1898, the defendant, by assignment of a lease,
acquired a leasehold estate in certain ore-producing properties in
the State of Minnesota from which it mined ore from that date to
and including the year 1910. For the year 1910, the defendant made
a return to the Collector
Page 247 U. S. 119
of Internal Revenue of its gross income, and from this amount it
deducted, 'to cover realization of unearned increment,' the sum of
$265,372.08. The amount of this deduction was arrived at by
multiplying the number of tons of ore mined during the year by 48
3/4�, which was the market value of the ore in place on the
premises on the first day of January, 1909, as estimated by the
defendant, this being the date upon which the returns for taxation
were to commence. It is stipulated that this deduction was made in
good faith upon the claim that it was 'a reasonable allowance for
depreciation' of the property of the defendant for that year."
"In June, 1911, payment was made in accordance with this return,
but the Treasury Department, about the month of October, 1914,
after investigating the books and records of the defendant, made
the claim that, because the defendant was not the owner in fee of
the premises from which it was mining ore, but was lessee of the
same and was paying a royalty to the fee owners, it was not
entitled to deduct anything for depletion of the ore body on the
premises. Thereupon the defendant was requested to amend its return
for the year 1910 so as to include in its gross income the amount
of said deduction, which it declined to do, and thereupon this suit
was instituted to recover the tax upon the amount of this
deduction, amounting to $2,653.72."
"Sometime prior to the making of the return for the year 1910,
the defendant estimated the tonnage and the market value of the ore
in place upon the premises upon which it held its lease, which
estimate gave to the ore in place a value of 48 3/4� per ton,
exclusive of royalty."
"The rights of the defendant in the iron ore mined in the year
1910 were derived from the assignment to it of a written lease
dated April 4, 1898, by the Biwabik Bessemer Company, lessor. By
the terms of that lease, the defendant acquired the right for the
term of fifty years
Page 247 U. S. 120
and three months from the 1st day of May, 1898, to explore for,
mine out, and remove the merchantable shipping iron ore which might
be found upon the lands described in the lease upon the payment of
a royalty of 30� for each ton mined. The expression 'merchantable
ore' is defined as including 'all ores which grade 55% and above in
metallic iron regardless of other ingredients.'"
"The lessee contracted to mine and remove at least 300,000 tons
of ore annually, or to pay to the lessor 30� per ton on that amount
if it should not be mined, but payments made in any year in excess
of royalty on ore actually mined could be credited upon the excess
which might be mined over the minimum requirement in subsequent
years. Any failure to keep or perform any of the covenants or
conditions of the lease gave to the lessor the option to take
immediate possession of the premises."
"The lessor in the lease reserved a lien upon any ore mined and
upon all improvements for any unpaid balance of royalty, and it was
also provided in the lease that the lessee should have the right to
terminate the lease on any first day of January during its term by
giving ninety days' notice of the purpose and desire so to do."
"The defendant, at the time it acquired this lease, paid to the
prior lessee the sum of $612,000, in addition to contracting to pay
the 30� per ton royalty upon the ore mined, as has been
stated."
"It is stipulated in the agreed statement of facts that the
deposit of ore on the leased premises is of such character that its
quality and quantity were capable of determination 'with
extraordinary accuracy' by drilling and shafts, and that the
defendant, 'by drilling and by standard recognized methods,' had
calculated the tonnage remaining on the land on January 1, 1909, as
6,874,695 tons, all of which could be easily removed within the
term of the lease."
Upon these facts, the district court reached the conclusion
Page 247 U. S. 121
that the leases in question were not conveyances of ore in
place, but were grants of the privilege of entering upon the
premises and mining and removing the ore, and consequently that the
deduction claimed as being one from capital investment could not be
allowed. In reaching this conclusion, the court cited the opinion
of this Court in
Stratton's Independence, Ltd. v.
Howbert,, 231 U. S. 399, and
the judgment of the Circuit Court of Appeals for the Eighth Circuit
(211 F. 1023), affirming the judgment of the district court (207 F.
419), which decision of the circuit court of appeals was made after
the return of the answer to the questions propounded by that court
to this Court in the
Stratton's Independence case.
Coming to the question as to what allowance should be made to
the mining company by way of deduction from its income in making
return, the district judge said:
"The defendant paid $612,000 for the lease under consideration,
and in addition assumed the payment of the royalties stipulated for
therein. This may properly and justly be considered a payment in
advance of an increased royalty on ore to be mined, and that is
precisely the character which the defendant gave to the payment
when dealing with it in its private accounts, in which the
stipulation shows (Exhibit H) that it carried one account, entitled
'Rate of General Ledger or Capitalized Value .03885 per Ton,' and
another account, entitled 'Rate of Increment Value, January 1,
1909, .44865 per Ton.' These two values added make the 48 3/4� per
ton, which the defendant deducted in making its return."
"Thus, in its own bookkeeping, the defendant gives its private
opinion as to the requisite reimbursement necessary to maintain its
capital investment, and thereby is made applicable that
longstanding rule for the construction of contracts,
viz.,
'show me what men have done under a contract and I will tell you
what it means.' The defendant should not complain if it be held to
that
Page 247 U. S. 122
construction of this lease and its investment under it which it
adopted for purposes of its own accounting before the question of
taxation had arisen to call forth ingenuity of interpretation."
"It results that a decree will be entered allowing instead of
the deduction computed on the basis of 48.75� per ton of ore mined,
the sum of .03885� per ton, and, there being no question of bad
faith in the case, the ends of justice will be served by the
payment of interest at the rate of 6% per annum from the date when
the additional payment found due should have been made."
The district court thereupon entered judgment:
"And the court finds as conclusions of law from said facts that
the defendant was entitled to deduct for and on account of the
544,353 tons of iron ore mined by it under its lease in the year
1910, the sum of .03885� per ton (which amount the parties agree
hereby is the cost to defendant of said ore at the time it acquired
the property in the year 1898, interest, taxes, surveys, and other
carrying charges on the said ore up to the time of its removal from
the said mine having been charged annually including the year 1910
into operating expenses), and defendant is not entitled to deduct
the 48.75� per ton deducted by it in its return, and there is due
from the defendant to the plaintiff the sum of $2,442.23, with
interest thereon at 6% from the 30th day of June, 1911, the date
when said sum should have been paid, and the court assesses the
plaintiff's damages herein at $3,140.70, and judgment is hereby
rendered against the defendant in favor of the plaintiff of the sum
of $3,140.70, with interest from the first day of this term of
court."
The company took the case to the circuit court of appeals upon
writ of error, that court reversed the judgment of the district
court, holding that the company was entitled to the deduction of
48.75� per ton upon each ton of ore mined, as so much depletion of
capital assets.
Page 247 U. S. 123
242 F. 9. This conclusion was reached upon a construction of the
lease in view of the character of the mining property involved, and
largely because of the fact that the quantity of the ore in place
could be estimated with substantial accuracy. The court held that
the selling price of the ore in any one year, so far as it
represented the actual value to the mining company of the ore in
the ground on January 1, 1909, was not income within the meaning of
the Corporation Tax Act of 1909. In the course of its opinion, the
circuit court of appeals announced the decisive question of law to
be:
"So far as the selling price of the ore in 1910 represented its
actual value to the company in the ground on January 1, 1909, was
it income or was it the sale price of capital assets?"
And, after dealing with the character of this lease and the
property covered by it, said:
"We think that the lessee of such property and under such a
lease is as much entitled as is the owner of the fee to treat the
value of his interest in the ore in the ground at the beginning of
the tax period as his capital -- indeed, the lessee's right to do
so is, in some respects, the stronger of the two, as hereafter
pointed out. Such a lease, as applied to this situation, is in
every substantial way
pro tanto a purchase."
This view of the character of these instruments and their legal
effect differs from that taken by this Court in the
Sargent
Land Company case,
242 U. S. 503,
wherein precisely similar iron ore leases were under consideration.
In that case, this Court reached the conclusion that such leases
were not conveyances of the ore in place, but were grants of the
privilege of entering upon, discovering, and developing and
removing the minerals from the land, and that the lessor's income
from such operations was obtained by a corporation shown to be
carrying on business, and, upon principles laid down in previous
cases in this Court (
Stratton's Independence v. Howbert, supra;
240 U. S. S.
124� v. Baltic Mining Company,@
240 U.
S. 103), that such income was subject to taxation under
the Corporation Tax Act of 1909.
In the
Sargent Land Company case, it was pointed out
that the courts of Minnesota, certainly familiar with the physical
characteristics of the ore deposits involved, had in a series of
cases held these instruments to be leases, and that the royalties
agreed to be paid were rentals in compensation for the privileges
granted the lessee. We held the conclusion of the Minnesota courts
to be warranted by reason and authority. 242 U.S.
242 U. S. 503, and
cases cited in margin, p.
242 U. S.
518.
The circuit court of appeals distinguished the
Sargent Land
Company case, and of it said:
"Finally, it is urged that this case is controlled by the
decision of the Supreme Court in the
Sargent Land Company
case. The mining leases involved in that case and in this one seem
to be identical in substance, and it is now said with great
plausibility that the ore in the ground and affected by such a
lease belongs partly to the lessor and partly to the lessee, and
that, if the interest of the lessor is not capital assets, no more
is the interest of the lessee, and that, if the receipts of the
former are income, so must those of the latter be. We are convinced
that the analogy between the two cases is superficial, and not
substantial. In that case, the Supreme Court had to determine
whether the royalties received by the lessor were income or were a
depletion of capital. Many considerations led to the conclusion
that they must be treated as income. The contract was a 'lease,'
the receipts were 'royalties,' and royalties, being rentals, are
inherently income, and have been commonly so considered. All these
things seem to have affected the conclusion of the Court, but,
after all, the dominating thought appears to be that, when land is
devoted to mining, it is put to only one of those productive uses
of which it is capable, and that the product of
Page 247 U. S. 125
the use should be called income. The land itself is the chief
thing. After the mining is finished, the land remains suitable for
other uses, and the fact -- if it is a fact -- that the minerals
are the greater part of its value cannot operate to make the
incidental overshadow the principal. These reasons do not apply at
all to the case of the lessee whose existing interest at the
beginning of the taxing period, over and above the royalty which he
must pay, amounted to $3,000,000; his entire interest was each
year, as far as he went, consumed and exhausted forever; he did not
have remaining the principal thing, the land, which he could put to
some other use; the receipt in 1910 of his January 1, 1909,
interest in the ore was not the offshoot and income of his
property; it was the transformation and eating up of the very
property, and of the whole of it. We therefore think that applying
the principle of the
Sargent case results in holding that
these receipts were from the sale of capital assets, and not from
income."
We are unable to concur in this view expressed in the opinion of
the circuit court of appeals as to the effect of the
Sargent
Land Company case. Certainly this Court had not in mind the
distinction suggested. In the
Sargent Land Company case,
the Circuit Court of Appeals for the Eighth Circuit found that the
land including the ore in it was worth hundreds of thousands of
dollars, and without the right, to the ore the land was worth
practically nothing. 219 F. 38. This finding, as well as facts of
general knowledge, leave little room to suppose that this Court
made its decision concerning the rights of the lessor influenced by
the fact that the land itself was the chief thing, and the
ownership of it after the exhaustion of the minerals one of the
controlling reasons in reaching the conclusion announced in that
case. The lessee takes from the property the ore mined, paying for
the privilege so much per ton for each ton removed. He has this
right or privilege under the form of lease here involved so
long
Page 247 U. S. 126
as he sees fit to hold the same without exercising the privilege
of cancellation therein contained. He is, as we held in the
Sargent Land Company case, in no legal sense a purchaser
of ore in place.
In this case, the government took no writ of error as to the
partial deduction allowed by the district court; it follows that
the correctness of that ruling is not open here. The circuit court
of appeals erred in making the additional allowance for capital
depletion. It follows that the judgment of the circuit court of
appeals must be reversed, and that of the district court affirmed,
and it is so ordered.
Reversed.
MR. JUSTICE CLARKE took no part in the consideration or decision
of this case.