1. An oil company which, pursuant to a Treasury Regulation,
elected irrevocably to deduct development expenses from gross
income in computing its taxable net income, rather than charge them
to capital account, and which made this election at a time when
Treasury practice under the Revenue Acts of 1921, § 234(a)(9), and
1924, § 204(c), required that "operative expenses," but not
expenses of development, be deducted from gross income in computing
"the net income from the property" which limits the depletion
allowance, has no ground to attack as retroactive a later
regulation made under the Revenue Act of 1928, § 114(b)(3), and
looking to the future, which requires that development, as well as
operative, expenses be deducted in the computation. P.
308 U. S.
97.
Page 308 U. S. 91
Tax statutes and regulations are subject to change. The
taxpayer, in making its election, took the risk that the method of
treating depletion might be altered by statute or authorized
regulation.
2. The claim that it was inequitable in the present case to
alter the regulations in the manner above described after the
taxpayer had made its irrevocable election in its return for the
year 1925 cannot be allowed in view of the fact that, in 1927,
after the basis of depletion had been changed by the Act of 1926
from a "discovery value" to a percentage basis, an opportunity to
make a new election as to the treatment of development expenses for
taxable periods ending on or after January 1, 1925, was offered by
Treasury decision, of which the taxpayer failed to take advantage.
P.
308 U. S.
97.
An opinion of the General Counsel of the Treasury is considered
in this case, in connection with a Treasury decision, as affording
notice that a change might be made in the practice touching the
treatment of development expenses in determining depletion
allowances for oil wells.
3. The term "net income from the property," used in the Revenue
Acts of 1921, 1924, 1926, and 1928 as a limitation upon allowance
for depletion of mines, including oil wells, was construed by the
Treasury, under the two earlier statutes, as meaning gross income
from the property less "operating expenses," not including
development expenses. Under the Act of 1926, however (which adopted
an arbitrary percentage of gross receipts, instead of "discovery
value," as the basis of depletion allowances for oil and gas
wells), the Treasury changed its policy in respect of such
deductions and altered its regulation, and, under the Act of 1928,
it promulgated a regulation which required that development
expenses as well as operating expenses be deducted in computing the
net income limitation on depletion where the taxpayer had elected
to deduct development expenses in computation of taxable net
income.
Held:
(1) That the legislative approval of the earlier administrative
construction of the term "net income from the property," implied
from the reenactment in 1924 of the statutory provision of 1921,
cannot be attributed also to the reenactment of 1928 in view of the
intervening change of Treasury construction of the same statutory
language in the Act of 1926. P.
308 U. S.
99.
(2) The statement that administrative construction receives
legislative approval by reenactment of a statutory provision with
out material change applies where the validity of administrative
action, standing by itself, may be dubious, or where ambiguities in
a statute or rules are resolved by reference to administrative
practice
Page 308 U. S. 92
prior to reenactment of a statute, and where it does not appear
that the rule or practice has been changed by the administrative
agency through exercise of its continuing rulemaking power. It does
not mean that a regulation interpreting a provision of one Act
becomes frozen into another Act merely by reenactment of that
provision, so that that administrative interpretation cannot be
changed prospectively through exercise of appropriate rulemaking
powers. P.
308 U. S.
100.
4. The power conferred by § 23(1) of the Revenue Act of 1928 to
make rules and regulations for the computation of depletion
allowances extends to the percentage depletion allowance under §
114(b)(3), and includes administrative construction of the
ambiguous phrase "net income from the property." P.
308 U. S.
101.
Restrictions on that power should not be lightly imposed where
the incidence of such rules as are promulgated is prospective
only.
95 F.2d 971 reversed.
Certiorari, 306 U.S. 628, to review an affirmance by the court
below of a decision of the Board of Tax Appeals (35 B.T.A. 450)
reducing a deficiency assessment.
MR. JUSTICE DOUGLAS delivered the opinion of the Court.
This case presents the question whether respondent, Wilshire Oil
Company, Inc., in computing its net income for the years 1929 and
1930 for the purpose of applying the 50 percent limitation on
depletion allowance under § 114(b)(3) of the Revenue Act of 1928,
45 Stat. 791, may refuse to take as deductions certain development
expenditures [
Footnote 1] where
it has deducted those development
Page 308 U. S. 93
expenditures in computing its taxable net income for those
years. The Board of Tax Appeals held for the respondent (35 B.T.A.
450), and that decision was affirmed by the Circuit Court of
Appeals, one judge dissenting (9 Cir., 95 F.2d 971). Because of the
importance of the problem of the scope of the Commissioner's
rulemaking power and because of an asserted conflict of the
decision below with the decision of the Circuit Court of Appeals
for the Fifth Circuit in
Commissioner v. F.H.E. Oil Co.,
102 F.2d 596, we granted certiorari, 306 U.S. 628.
Respondent is engaged in the business of producing oil and gas
from its various properties. In computing taxable net income in its
returns for 1929 and 1930, respondent, pursuant to the regulations,
deducted development expenditures in the respective amounts of
$606,051.66 and $279,927.04. But it refused to make those
deductions in determining its "net income . . . from the property"
for the same years when computing allowable depletion under §
114(b)(3) of the Revenue Act of 1928. [
Footnote 2]
Page 308 U. S. 94
That section provides:
"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."
By virtue of § 23 of the Revenue Act of 1928, companies like
respondent were allowed as deductions in computing net income a
"reasonable allowance for depletion . . . 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."
Pursuant to that rulemaking power, the phrase "net income of the
taxpayer (computed without allowance for depletion)," as used in §
114(b)(3), was defined by Treasury Regulations 74, Art. 221(i),
promulgated under the 1928 Act, as meaning "gross income from the
sale of oil and gas" less certain deductions, including
"development expenses (if the tax
Page 308 U. S. 95
payer has elected to deduct development expenses). . . but
excluding any allowance for depletion." For 1925, respondent,
having the option to treat these expenses as deductions for
development expenses or as charges to the capital account
returnable through depletion, [
Footnote 3] chose the former.
On these facts, it would seem that Treasury Regulations 74, Art.
221(i), would require respondent to deduct development expenses in
computing "net income" as used in § 114(b)(3), since respondent
fell clearly within the class described therein.
But respondent contends that these regulations, as applied to it
for the taxable years in question, are invalid. Its argument runs
as follows:
(1) The phrase "net income . . . from the property" present in §
114(b)(3) originated in § 234(a)(9) of the Revenue Act of 1921, 42
Stat. 227, 256, and was reenacted without change in § 204(c) of the
1924 Act, 43 Stat. 253, 260. It was also carried over into §
204(c)(2) of the 1926 Act, 44 Stat. 9, 16, when Congress adopted
the present so-called percentage depletion formula. Shortly after
the enactment of the Revenue Act of 1921, Treasury Regulations were
issued defining net "income . . . from the property" as meaning
gross income from the property less "operating expenses." [
Footnote 4] A similar definition was
given in the Treasury Regulations issued under the Revenue Act of
1924. [
Footnote 5] The admitted
Treasury practice under those two Acts
Page 308 U. S. 96
was to permit net income from the property to be computed
without regard to development expenditures. Hence, respondent
argues, the meaning of the phrase "net income . . . from the
property" had acquired a plain and definite meaning, known to the
Congress; thus, when that phrase was reenacted in the 1924 Act, the
Congress intended it to have the meaning which administrative
practice had given it. And, the argument continues, that meaning
having been adopted by the Congress in the 1924 Act, it clung to
the same phrase in the 1926 Act [
Footnote 6] and in the 1928 Act, especially since the
Commissioner, prior to February 15, 1929, [
Footnote 7] never did undertake by regulation or
decision to give that phrase a meaning different from that which
had been consistently applied under the earlier Acts.
(2) Secondly, respondent contends that the fact that it deducted
development expenses in computing taxable net income does not mean
that it is required to make the same deductions for the "net
income" computation under § 114(b)(3), for the reason that it had
no free choice in the first of these computations. In that
connection, it points out that it was required to make these
deductions from gross income by reason of its election in its 1925
return to treat these expenses as deductions for development
expenses, rather than as charges to capital account returnable
through depletion, an election binding for all subsequent years. In
that posture of the
Page 308 U. S. 97
case, it argues that the attempted change in the regulations
here involved has a retroactive effect as applied to it and
withdraws one of the important inducements offered by the
Commissioner in connection with the election which respondent made
in its 1925 return.
We do not think that respondent's position is tenable.
As to respondent's claim of retroactivity, it is true that the
election made in connection with its 1925 return was known to be
binding for all subsequent years. It is likewise true that it was
made at a time when Treasury practice did not require deduction of
development expenses in making the computation under § 114(b)(3).
But that is no basis for a claim of retroactivity. Treasury
Regulations 74, Art. 221(i), which required the deduction of
development expenses for the purpose of the computation under §
114(b)(3), were issued February 15, 1929, under the 1928 Act. These
regulations applied prospectively only, and did not purport to
reach back to earlier years when the taxpayer relied on a different
rule or practice. Tax statutes and tax regulations never have been
static. Experience, changing needs, changing philosophies
inevitably produce constant change in each. One making an election
in the 1925 return took the risk that the method of treatment of
depletion might be changed by the Congress, or, where power
existed, by the Commissioner. Any other conclusion would make the
application of changes pursuant to regulations, though prospective,
dependent on fortuitous circumstances under which each taxpayer
made such an election. Rigidity, as well as confusion, in
administration of tax laws would be the result.
But in this case there is another answer to respondent's claim
that an inequity results by changing the regulations after it had
made its election in the 1925 return. On June 18, 1927, the
Commissioner, with the
Page 308 U. S. 98
approval of the Secretary, issued a Treasury Decision [
Footnote 8] stating that,
"In view of the change in the basis for depletion provided by
the Revenue Act of 1926, in the case of oil and gas wells,
taxpayers may make a new election as to the treatment"
of development expenditures "for taxable periods ending on or
after January 1, 1925, but not later than six months after the date
of this decision." Taxpayers desiring to make a new election were
required to file amended returns for the taxable periods involved
within six months from the date of that decision. Thus, respondent,
after Congress adopted the new percentage depletion provision, was
afforded ample opportunity to make a new election. This it did not
do. To be sure, that Treasury Decision contained no notice of any
projected change in the meaning of "net income . . . from property"
as used in § 114(b)(3). But, in September, 1927, there issued a
General Counsel's Memorandum [
Footnote 9] in which it was stated that, thereafter,
"if a taxpayer elects to treat development expenditures as
ordinary and necessary business expenses . . . in computing taxable
net income, such expenditures must be deducted in determining the
net income from the property, which amount is used as a limitation
in the computation of the depletion allowance based on income."
To be sure, this was merely an opinion of the General Counsel of
the Bureau, and did not have the force or effect of a Treasury
Decision. Yet, in view of such ruling, there is now no reasonable
basis for concluding that, when respondent made its second election
in 1927, it had no basis for assuming that the policy as respects
"net income . . . from the property" under the 1926 Act was or
would be no different than it had been under the 1921 and 1924
Acts. Therefore, in terms of equitable considerations,
respondent
Page 308 U. S. 99
has no just ground of complaint. On these facts, substantial
justice requires that respondent take such burdens as may flow from
its election, along with the benefits.
Irrespective of these considerations, we think the regulations
in question were valid. It is true, as stated by respondent, that
the regulations under the 1921 Act provided that the "net income .
. . from the property" should be computed for purpose of the
depletion allowance without regard to development expenditures. And
it may be assumed that that administrative construction received
legislative approval by the reenactment of the statutory provision
in the 1924 Act without material change.
Cf. United States v.
Dakota-Montana Oil Co., 288 U. S. 459,
288 U. S. 466.
But that does not mean that that meaning survived both the 1926 and
the 1928 Acts. In the first place, there were no comparable
regulations under the 1926 Act. [
Footnote 10] In fact, the Commissioner undertook
Page 308 U. S. 100
under that Act to follow the practice later set forth in the
regulations here in question.
See Ambassador Petroleum Co. v.
Commissioner, 81 F.2d 474. Those facts are of some
significance here, for they refute the suggestion that the
Congress, in enacting the 1928 Act, was giving approval to an
administrative construction which had been given to comparable
provisions of earlier Acts but which was abandoned before the
passage of the 1928 Act. The more reasonable inference seems to be
that reenactment of the provision in question by the 1928 Act, at a
time when Treasury policy as respects its construction had changed,
did nothing more than to restore to the phrase "net income . . .
from the property" its original ambiguity. Accordingly, that phrase
became peculiarly susceptible to new administrative interpretation.
Helvering v. R. J. Reynolds Tobacco Co., 306 U.
S. 110;
Morrissey v. Commissioner, 296 U.
S. 344.
But, in any event, the validity of the regulations in question
seems clear. The oft-repeated statement that administrative
construction receives legislative approval by reenactment of a
statutory provision without material change (
United States v.
Dakota-Montana Oil Co., supra) covers the situation where the
validity of administrative action, standing by itself, may be
dubious, or where ambiguities in a statute or rules are resolved by
reference to administrative practice prior to reenactment of a
statute, and where it does not appear that the rule or practice has
been changed by the administrative agency through exercise of its
continuing rulemaking power. It does not mean that a regulation
interpreting a provision of one act becomes frozen into another act
merely by reenactment of that provision, so that that
administrative interpretation cannot be changed prospectively
through exercise of appropriate rulemaking powers.
Cf.
Morrissey v. Commissioner, supra, at p.
296 U. S. 355.
The contrary conclusion
Page 308 U. S. 101
would not only drastically curtail the scope and materially
impair the flexibility of administrative action; it would produce a
most awkward situation. Outstanding regulations which had survived
one Act could be changed only after a preview by the Congress. In
preparation for a new revenue Act, the Commissioner would have to
prepare in advance new regulations covering old provisions. Their
effectiveness would have to await Congressional approval of the new
Act. The effect of such procedure, so far as time is concerned,
would be precisely the same as if these new regulations were
submitted to the Congress for approval. Such dilution of
administrative powers would deprive the administrative process of
some of its most valuable qualities -- ease of adjustment to
change, flexibility in light of experience, swiftness in meeting
new or emergency situations. It would make the administrative
process under these circumstances cumbersome and slow. Known
inequities in existing regulations would have to await the advent
of a new revenue act. Paralysis in effort to keep abreast of
changes in business practices and new conditions would redound at
times to the detriment of the revenue, at times to the disadvantage
of the taxpayer. Likewise the result would be to read into the
grant of express administrative powers an implied condition that
they were not to be exercised unless, in effect, the Congress had
consented. We do not believe that such impairment of the
administrative process is consistent with the statutory scheme
which the Congress has designed.
The only remaining question is whether Treasury Regulations 74,
Art. 221(i), were within the power of the Commissioner to
promulgate. That they were seems clear beyond question. We are not
dealing here, as was this Court in
Helvering v. R. J. Reynolds
Tobacco Co., supra, with regulations applied retroactively.
These are
Page 308 U. S. 102
applied prospectively only. The rulemaking power here in
question may be found in § 23(1) of the Revenue Act of 1928. That
section, after providing that companies like respondent were
entitled, as a deduction in computing net income, to a "reasonable
allowance for depletion . . . according to the peculiar conditions
in each case," laid especial emphasis on the power of the
Commissioner to make rules for the computation of the depletion
allowance by providing that
"such reasonable allowance in all cases [is] to be made under
rules and regulations to be prescribed by the Commissioner, with
the approval of the Secretary."
Respondent does not strongly urge that the regulatory power
conferred by § 23(1) does not extend to the percentage depletion
allowance under § 114(b)(3). Rather, the contention seems to be
that to allow the Commissioner, by regulation, to change the
measure of "net income . . . from the property" from time to time,
especially in the manner here attempted, would be to approve a
result equally as contrary to the intention of Congress as if he
had attempted by regulation to change the percentage factors
themselves. But the scope or importance of the change effected by
the regulations is immaterial if the power to promulgate such
regulations exists. Here, the Congress has not prescribed a precise
formula free from all ambiguity. The ambiguous phrase "net income .
. . from the property" was susceptible of various meanings, and
hence administrative interpretation of it was peculiarly
appropriate, as we have said. And there were special reasons
growing out of the complex nature of the depletion problem, as it
is treated for purposes of the income tax, for requiring the
Commissioner to make precise the vague elements of that formula. In
its general aspects, under revenue acts, depletion is a problem on
which taxpayers, government, and accountants
Page 308 U. S. 103
have expressed a contrariety of opinions. [
Footnote 11] Obfuscation in attempted
application of its principles under income tax laws has frequently
been the result. The Congress itself, as revealed in the history of
the revenue acts, has expressed varying philosophies. In practical
administration of any one statute, there are admittedly borderline
cases between deductible business expenses and nondeductible
capital outlays. On specific fact situations, the clear line
between depletion, depreciation, and obsolescence often becomes
blurred. [
Footnote 12] What
those lines are or should be is for the Congress and the
Commissioner. Experience and new insight can be expected to produce
rather constant change. In sum, the highly technical and involved
factors entering into a practical solution of the problem of
depletion in administration of the tax laws points to the necessity
of interpreting § 23(1) so as to strengthen, rather than to weaken,
the administrative powers to deal with it equitably and reasonably.
These considerations are persuasive here not only in reaffirming
the conclusion that the rulemaking power existed, but also in
concluding that restrictions on that power should not be lightly
imposed where the incidence of such rules as are promulgated is
prospective only.
Reversed.
MR. JUSTICE BUTLER and MR. JUSTICE REED took no part in the
consideration or decision of this case.
*
See No. 2,
Helvering v. Bandini Petroleum
Co., and No. 3,
Helvering v. Wilshire Annex Oil Co.,
post, p. 512.
[
Footnote 1]
These expenditures consisted of such items as labor, fuel, and
power, materials and supplies, tool rental, truck and auto hire,
repairs to drilling equipment, and depreciation upon equipment used
in drilling.
[
Footnote 2]
For the year 1929, the Commissioner's computations were as
follows:
Gross Income from the properties . . . . . . . . .
$1,001,375.17
Deductions: Production expense. . . . $171,399.03
Development expense . . . 606,051.66
-----------
Total expenses. . . . . . . . . . . . . . . . . 777,450.69
-------------
Net income from property (computed
without allowance for depletion). . . . . . . $223,924.48
50 percent of that income . . . . . . . . . . . $111,962.24
The Commissioner limited the depletion allowance to the last
mentioned figure, since 50 percent of the net income from the
property as thus computed was less than 27 1/2 percent of the gross
income.
Under the taxpayers computation, the net income for depletion
purposes would be $1,001,375.17 less $171,399.03, or $829,976.14,
and 50 percent thereof would not be less than 27 1/2 percent of the
gross income.
For the year 1930, the Commissioner's computation showed a loss
of $194,869.22. He therefore ruled that, since the percentage
depletion allowance was limited to 50 percent of the net income
from the properties, and since the taxpayer had no such net income,
no deduction on account of percentage depletion could be allowed.
The taxpayer refused, however, to deduct development expenses in
the application of the 50 percent limitation, and claimed a
depletion deduction of $42,528.91, arrived at as follows:
Gross income from the properties . . . . . . . . $370,448.72
Deductions: Production expense. . . . . . . . . 285,390.90
-----------
Net income. . . . . . . . . . . . . . . . . $85,057.82
Depletion deduction (50 percent of net income) . $42,528.91
[
Footnote 3]
Treasury Regulations 69, Art. 223, promulgated under the Revenue
Act of 1926, provides that
"such incidental expenses as are paid for . . . development of
the property may at the option of the taxpayer be deducted as a
development expense or charged to capital account returnable
through depletion. . . . An election, once made under the
provisions of this article, will control the taxpayer's returns for
all subsequent years."
[
Footnote 4]
Treasury Regulations 62, Art. 201(h).
[
Footnote 5]
Treasury Regulations 65, Art. 201(h).
[
Footnote 6]
Respondent points to the Report of Committee on Ways and Means
on Revenue Bill of 1926 (H.Rep. No. 1, 69th Cong., 1st Sess., p.
6):
"The discovery depletion deduction limitation of an amount not
in excess of 50 percent of the net income of the taxpayer from the
property upon which discovery was made, provided in existing law,
is retained in the provision."
[
Footnote 7]
The date when Treasury Regulations 74, Art. 221(i), here in
question, were promulgated.
[
Footnote 8]
Treasury Decision 4025, Cum.Bul. VI-1, p. 75.
[
Footnote 9]
G.C.M. 2315, Cum.Bul. VI-2, p. 21.
[
Footnote 10]
As respects discovery depletion in the case of mines under the
1926 Act, provisions similar to those under the 1921 and 1924 Acts
were retained. Treasury Regulations 69, Art. 201(h). But this was
not true as respects oil and gas wells. § 204(c)(2) of the Revenue
Act of 1926 applied the percentage depletion allowance exclusively
to "oil and gas wells." Treasury Regulations 69, Art. 221,
provided:
"Under section 204(c)(2), in the case of oil and gas wells, a
taxpayer may deduct for depletion an amount equal to 27 1/2 percent
of the gross income from the property during the taxable year, but
such deduction shall not exceed 50 percent of the net income of the
taxpayer (computed without allowance for depletion) from the
property. In no case shall the deduction computed under this
paragraph be less than it would be if computed upon the basis of
the cost of the property or its value at the basic date, as the
case may be. In general, 'the property,' as the term is used in
section 204(c)(2) and this article, refers to the separate tracts
or leases of the taxpayer."
Thus, it is apparent that the delimitation implied in the
permission to deduct "operating expenses" present under the earlier
regulations disappeared from the 1926 regulations in case of oil
and gas wells.
[
Footnote 11]
2 Paul & Mertens, The Law of Federal Income Taxation (1934),
ch. 21; 47 Yale L.Journ. 806 (1938).
[
Footnote 12]
See, for example, the issues posed in
United States
v. Dakota-Montana Oil Co., supra.