1. The legislative history of § 204(c)(2) of the Revenue Act of
1926 shows that this section does not grant a deduction for
depletion, but merely provides methods for computing the amount of
the deduction granted by § 234(a)(8) of the Act. Pp.
293 U. S. 315,
293 U. S.
319.
2. The deduction for depletion in the case of a lease of oil and
gas wells must be apportioned between the lessor and lessee as
provided by § 234(a)(8), irrespective of which of the methods
prescribed by § 204 for computing the amount of the deduction is
chosen.
Page 293 U. S. 313
The last clause of § 204(c)(2), providing that " . . . in no
case shall the depletion allowance be less than it would be if
computed without reference to this paragraph," does not require a
different result. P.
293 U. S.
319.
3. Under § 204(c)(2) of the Revenue Act of 1926, which provides
that, "[i]n the case of oil and gas wells, the allowance for
depletion shall be 27 1/2 percentum of the gross income from the
property during the taxable year," the basis for computing the
allowance ill the case of a taxpayer operating under a lease
requiring the payment of royalties is the gross income from
production less the amounts which the taxpayer was obligated to pay
as royalties, whether the royalties were paid in kind or their
value in cash. Pp.
293 U. S.
320-321.
4. The provision of § 114(b)(3) of the Revenue Act of 1932 which
expressly excludes from the basis for computing the percentage
depletion for oil and gas wells "any rents or royalties paid or
incurred by the taxpayer in respect of the property" was merely
clarifying in purpose and declaratory of § 204(c)(2) of the 1926
Act as administered. P.
293 U. S. 322.
70 F.2d 402 reversed.
Certiorari to review a judgment reversing a decision of the
Board of Tax Appeals, 26 B.T.A. 172, which sustained an assessment
of deficiency in income tax.
MR. JUSTICE ROBERTS delivered the opinion of the Court.
Under the Revenue Act of 1926, the taxpayer is entitled, in the
case of oil and gas wells, to deduct from gross income an allowance
for depletion. The relevant sections
Page 293 U. S. 314
of the act are copied in the margin. [
Footnote 1] The present litigation calls for decision
as to the total allowance permitted
Page 293 U. S. 315
and its apportionment between lessor and lessee where the income
is derived from operation under an oil and gas lease.
During 1925, 1926, and 1927, the respondent, as assignee of the
lessee named in an oil and gas lease, extracted substantial
quantities of oil. By the terms of the lease and the assignment, it
was obligated to pay royalties in cash or in kind totalling one
quarter of the oil extracted. The respondent claimed that the gross
proceeds of all the oil produced should form the basis for the
computation of the allowance for depletion granted by § 204(c)(2),
but the petitioner ruled that the deduction should be limited to 27
1/2 percent of gross production less royalties paid. The Board of
Tax Appeals sustained the ruling. [
Footnote 2] The Circuit Court of Appeals reversed the
Board. [
Footnote 3] The case is
here on writ of certiorari. [
Footnote 4]
The petitioner construes § 204(c)(2)
in pari materia
with § 234(a)(8), and asserts the percentage deduction permitted by
the former is subject to the requirement of equitable apportionment
between the lessor and lessee required by the latter. The
respondent urges that § 204(c)(2) is an independent and complete
provision, to be applied without reference to § 234(a)(8), and that
to attempt to apportion the allowance granted by § 204(c)(2) in the
manner indicated by § 234(a)(8) would violate the plain terms of
the statute.
Reference to the structure of the successive income tax laws
will aid in a solution of the problem. The Revenue Act of 1916
[
Footnote 5] imposed an income
tax by Title I. It divided the provisions as to tax into two parts,
Part I on individuals and Part II on corporations. In each
part,
Page 293 U. S. 316
the statute first lays the tax, and, in a subsequent section,
grants certain deductions, those enumerated in § 5 of Part I being
available to individuals, and those specified in § 12 of Part II to
corporations. Both sections include a reasonable allowance for
depletion in the case of oil and gas wells. In the drafting of the
Revenue Act of 1918, [
Footnote
6] a new arrangement of the subject matter was adopted. Title I
is composed of definitions, Title II treats of income tax. Part I
of this title consists of general provisions applicable alike to
individual and corporate taxpayers. Sections under this Part define
taxable years and dividends, and § 202 prescribes the "basis for
determining gain or loss," but makes no reference to depletion of
mines, timber, or oil and gas wells. Additional sections have to do
with inventories, net losses, and other general matters. Part II
levies the tax on individuals, defines net and gross income, and,
in § 214, specifies the deductions allowed from gross income. The
opening sentence of subsection (a)(10) is:
"In the case of mines, oil and gas wells, other natural
deposits, and timber, a reasonable allowance for depletion and for
depreciation of improvements, according to the peculiar conditions
in each case, based upon cost including cost of development not
otherwise deducted."
Then follow two provisos, one directing how cost shall be
ascertained in the case of properties acquired prior to March 1,
1913, and the other allowing an alternative method of calculating
depletion upon the basis of discovery value of mines and oil and
gas wells. The paragraph ends with the sentence: "In the case of
leases, the deductions allowed by this paragraph shall be equitably
apportioned between the lessor and lessee."
Page 293 U. S. 317
In Part III, levying the corporation tax, § 234(a)(9) allows a
deduction for depletion in the identical phraseology employed with
respect to individual taxpayers in § 214(a)(10).
The same method was followed in the Revenue Act of 1921.
[
Footnote 7] The general
provisions contain no reference to depletion, but, under Parts II
and III of Title II, the tax is fixed for individuals and
corporations and the allowable deductions from gross income are set
forth. The paragraphs of the prior act as to depletion of oil and
gas wells are literally reenacted, but there is inserted in §
214(a)(10) as to individuals and § 234(a)(9) as to corporations an
additional proviso with respect to discovery value.
In the framing of the Revenue Act of 1924, [
Footnote 8] the same arrangement was observed.
General definitions are found in Title I; Title II treats of income
tax, and in Part I of that title are included general provisions
applicable to both individual and corporate taxes. Amongst such
general provisions in the earlier acts there had been a section
entitled "Basis for determining gain or loss." In the 1924 Act, the
draftsman embodied paragraphs similar to those of the earlier act
in § 204, but enlarged the caption to read "Basis for determining
gain or loss, depletion, and depreciation," and transferred to this
section that portion of the depletion provision dealing with the
basis of the allowance which had formerly appeared under the
heading "Deductions" in Part II, Individuals, and Part III,
Corporations. This added to the old § 204 a new subsection (c),
which permits the use of cost or discovery value as the basis of
depletion in the case of mines and oil and gas wells. Having
transferred these provisions from §§ 214(a)(9) and 234(a)(8),
respecting individual
Page 293 U. S. 318
and corporate deductions, there remained in those sections the
language first found in the Act of 1918, above quoted, including
the concluding sentence relating to equitable apportionment between
lessor and lessee. The thought apparently was that the authority
for the deduction should remain in the sections dealing with all
deductions, and the formulae for calculating the deduction should
be relegated to a general provision applicable alike to
corporations and individuals.
The depletion allowance based on discovery value was found
difficult of administration, since it required a separate valuation
of each well, [
Footnote 9] and
was abandoned in the Revenue Act of 1926. [
Footnote 10] There was substituted a flat
allowance of 27 1/2 percent of gross income. In this Act, the same
arrangement was followed as in that of 1924. Under Title II, Income
Tax, Part I was devoted to general provisions. As the basis for
determining gain or loss, depletion and depreciation, had been
embodied in § 204 of the general provisions of the Act of 1924, in
which was the permitted use of discovery value as a basis for
depletion, when that method was discarded in favor of the flat
percentage of gross income, it was logical to insert the
substituted paragraph in the place where the discarded one had
been. Thus, we find the new formula inserted as paragraph (c)(2) of
§ 204. The authority for deduction of depletion remains where it
has always been since the Act of 1918 -- namely, in § 214(a)(9) of
Part II, Individuals, and § 234(a)(8) of Part III, Corporations,
and naturally there still remains in these paragraphs the
limitation that the allowance shall be apportioned between lessor
and lessee. [
Footnote
11]
Page 293 U. S. 319
This outline of the framework of the legislation demonstrates
that Congress did not insert § 204(c)(2) as an independent section
granting an allowance or deduction for depletion. In the
earlier Acts, both the grant and the method of computation were
embraced in a subsection under the title "Deductions." In the later
Acts of 1924 and 1926, the grant remained in the deduction section,
and the taxpayer was referred to a general provision in § 204 for
the method of ascertaining its amount.
Respondent emphasizes the last clause of § 204(c)(2), which is:
"except that in no case shall the depletion allowance be less than
it would be if computed without reference to this paragraph." It is
argued that, as this exception gives the taxpayer an option to
compute the allowance either on the cost basis or by the flat
percentage method, if he elects the former, he proceeds under §
234(a)(8) of the Act. Thus, it is said that section applies only in
case the cost basis is chosen. But an examination of the statute
demonstrates the error of this position. No basis or formula for
computation of the allowance is found in § 234; on the contrary,
all permissible procedures are covered by § 204, whether cost
depletion of mines and oil
Page 293 U. S. 320
wells, paragraph (c); discovery value basis in the case of
mines, (c)(1), or flat percentage of gross income in the case of
oil and gas wells, (c)(2). If, therefore, the taxpayer does not
compute under (c)(2), he must do so in accordance with the cost
method prescribed by the earlier paragraph (c) of the same section,
and not, as contended, under 234(a)(8).
It follows that whichever method outlined in § 204 is chosen for
computing the allowance granted by § 234, the deduction must be
apportioned between lessor and lessee.
We come, then, to consider the propriety of the procedure
followed by the Commissioner. What he did, in effect, was to treat
the gross production less royalties as the measure of the
respondent's depletable interest in the property, and the royalties
as the measure of the depletable interest of those entitled to
receive them. The respondent says, however, that, under § 213, the
gross production of the wells is respondent's gross income from the
property, must be reported as such, and § 204(c)(2) permits him an
allowance of 27 1/2 percent thereof. It must follow that the
royalties (one-fourth of the same gross production) are gross
income to those receiving them and are subject to depletion at the
rate of 27 1/2 percent. The result would be a total allowance of 27
1/2 percent of five-fourths of the total production. Certainly this
would not be a single allowance, apportioned between lessor and
lessee. And we think § 204(c)(2) does not require such a result.
The words used are, "the allowance for depletion shall be 27 1/2
percentum of the
gross income from the property during the
taxable year." Is the italicized phrase synonymous with the
taxpayer's gross income as defined in § 213? It cannot be if
"property" signifies the tract of land in all its uses, others as
well as the extraction of oil and gas.
Darby-Lynde Co.
v.
Page 293 U. S. 321
Alexander, 51 F.2d 56. The phrase, we think, points
only to the gross income from oil and gas.
Compare United
States v. Dakota-Montana Oil Co., 288 U.
S. 459,
288 U. S. 461;
Greensboro Gas Co. v. Commissioner, 30 B.T.A. 1361. So restricted,
it presents no difficulty where the owner of the land is also the
operator, and there is none where the lessee turns over royalty oil
in kind to the lessor, for the retained oil, in that case, is the
base for the lessee's computation of depletion, and the royalty oil
that for the lessor's. We think Congress did not intend a different
result where, as here, the lessee sells all the oil and pays over
the royalty in the form of cash.
At all events, as the section must be read in the light of the
requirement of apportionment of a single depletion allowance, we
are unable to say that the Commissioner erred in holding that, for
the purpose of computation, "gross income from the property" meant
gross income from production less the amounts which the taxpayer
was obliged to pay as royalties. The apportionment gives respondent
27 1/2 percent of the gross income from production which it had the
right to retain, and the assignor and lessor, respectively, 27 1/2
percent of the royalties they receive. Such an apportionment has
regard to the economic interest of each of the parties entitled to
participate in the depletion allowance.
Compare Palmer v.
Bender, 287 U. S. 551,
287 U. S.
558.
The respondent insists that, so applied, the section may work
unjust and unequal results; but it is to be remarked that this is
likely to be so wherever a rule of thumb is applied without a
detailed examination of the facts affecting each taxpayer. No
doubt, as the petitioner points out, equally illogical results
might ensue the application of the section as the respondent
construes it. And it is also to be remembered that depletion upon
cost or March 1, 1913, value is optional with the taxpayer, if that
procedure is more favorable to him.
Page 293 U. S. 322
Finally, the respondent says that, in the Revenue Act of 1932,
[
Footnote 12] the section
corresponding to 204(c)(2) was amended so as to authorize such a
procedure as the petitioner adopted in this case, and therefore the
section as it stood in the Act of 1926 could not have supported the
Commissioner's ruling. The amendment alters the section to read:
[
Footnote 13]
"In the case of oil and gas wells, the allowance for depletion
shall be 27 1/2 percentum of the gross income from the property
during the taxable year,
excluding from such gross income an
amount equal to any rents or royalties paid or incurred by the
taxpayer in respect of the property. . . ."
The petitioner says that the amendment was merely clarifying in
purpose and declaratory of the existing law as administered. We
think this is so. When it was offered, the chairman of the
committee having the bill in charge so stated, [
Footnote 14] and the conference report is
to the same effect. [
Footnote
15]
The judgment is
Reversed.
[
Footnote 1]
Revenue Act of 1926, 44 Stat. 9, 14, 42.
"
TITLE II -- INCOME TAX"
"
* * * *"
"
PART III -- CORPORATIONS"
"
* * * *"
"
Deductions Allowed Corporations"
"SEC. 234. (a) In computing the net income of a corporation
subject to the tax imposed by § 230, there shall be allowed as
deductions:"
"
* * * *"
"(8) In the case of mines, oil and gas wells, other natural
deposits, and timber, a reasonable allowance for depletion and for
depreciation of improvements, according to the peculiar conditions
in each case. such reasonable allowance in all cases to be made
under rules and regulations to be prescribed by the Commissioner
with the approval of the Secretary. In the case of leases, the
deductions allowed by this paragraph shall be equitably apportioned
between the lessor and lessee."
U.S.C.App. Tit. 26, § 986.
"
TITLE II -- INCOME TAX"
"
PART I -- GENERAL PROVISIONS"
"
* * * *"
"
BASIS FOR DETERMINING GAIN OR LOSS, DEPLETION, AND
DEPRECIATION"
"SEC. 204."
"
* * * *"
"(c) The basis upon which depletion, exhaustion, wear and tear,
and obsolescence are to be allowed in respect of any property shall
be the same as is provided in subdivision (a) or (b) for the
purpose of determining the gain or loss upon the sale or other
disposition of such property, except that --"
"
* * * *"
"(2) In the case of oil and gas wells, the allowance for
depletion shall be 27 1/2 percentum of the gross income from the
property during the taxable year. Such allowance shall not exceed
50 percentum of the net income of the taxpayer (computed without
allowance for depletion) from the property, except that in no case
shall the depletion allowance be less than it would be if computed
without reference to this paragraph."
U.S.C.App. Tit. 26, § 935(c)(2).
[
Footnote 2]
26 B.T.A. 172.
[
Footnote 3]
70 F.2d 402.
[
Footnote 4]
Post, p. 540.
[
Footnote 5]
39 Stat. 756.
[
Footnote 6]
40 Stat. 1057.
[
Footnote 7]
42 Stat. 227.
[
Footnote 8]
43 Stat. 253.
[
Footnote 9]
See Senate Report No. 52, 69th Cong., 1st Sess., p.
17.
[
Footnote 10]
44 Stat. 9.
[
Footnote 11]
In framing the Revenue Act of 1928 (45 Stat. 791), the draftsman
reverted to an arrangement similar to that found in the Revenue Act
of 1916. Thus, under Title I, an income tax is laid on both
individuals and corporations, and, in subsequent portions of the
Act, general provisions are contained. In this Act, the deductions
from gross income are found in § 23 under Part II, "Computation of
Net Income," and the language of § 214(a)(9) and § 234(a)(8) of the
Revenue Act of 1926 is found only in this section, applicable to
both sorts of taxpayers, corporate and individual, as subsection
(1). A new subsection (m) is added which states:
"The basis upon which depletion, exhaustion, wear and tear, and
obsolescence are to be allowed in respect of any property shall be
as provided in § 114."
Section 114 is found in Supplement B, and, so far as material
here, is the same with respect to gas and oil wells as the
analogous portions of § 204(c) of the Act of 1926.
It is quite clear, therefore, from this cross-reference that the
framers of the Act understood the deduction was allowed by § 23(1),
but the method of calculating it was to be ascertained by reference
to a general provision on that subject, § 114.
[
Footnote 12]
47 Stat. 169.
[
Footnote 13]
Section 114(b)(3), 47 Stat. 202.
[
Footnote 14]
Cong. Record, Vol. 75, Part 10, pp. 11629-11630.
[
Footnote 15]
House Conference Report No. 1492, 72d Cong., 1st Sess., p.
14.