1. A taxpayer who transferred an oil lease and equipment for
cash and a royalty interest
held entitled, upon a return
of income tax, to an allowance for the unrecovered cost of the
equipment. P.
324 U. S. 3.
2. Under the Revenue Act of 1938, depletion is not applicable to
equipment used in the operation of an oil lease. P.
324 U. S. 3.
3. The Tax Court's determination that the transaction in
question involved an absolute sale of the equipment was conclusive
on review.
Dobson v. Commissioner, 320 U.
S. 489;
Wilmington Co. v. Helvering,
316 U. S. 164. P.
324 U. S. 3.
141 F.2d 641 reversed.
Certiorari, 323 U.S. 692, to review a judgment which, upon an
appeal by the Commissioner, reversed a decision of the Tax
Court.
Page 324 U. S. 2
MR. JUSTICE DOUGLAS delivered the opinion of the Court.
In 1936, Choate and Hogan, a partnership of which the petitioner
was a member, acquired an oil and gas lease. They drilled six
producing wells on the leased land and operated the property until
August, 1938. At that time, they sold to Sylva Oil Co. for a cash
consideration of $110,000 all their right, title, and interest in
the lease,
"together with all wells and the equipment thereof, including
pumps, casing, piping, tanks, lease house, and all other personal
property on or used in connection"
with the premises. But they expressly reserved to themselves
"1/8 of the 8/8ths of all oil and gas and casinghead gas which may
be produced and saved" from the land. Thereafter, Sylva Oil Co.
drilled additional wells and operated the lease. Choate and Hogan,
in their partnership return for 1938, reported the transaction as a
sale. Respondent, in his deficiency notice, ruled that the
transaction constituted a sublease. The Tax Court took the same
view, holding that the partners must look to depletion for the
return of their capital. It held that the principle of recovery by
depletion was applicable where a royalty interest was retained, and
that a cash bonus was to be regarded as in the nature of an advance
royalty. It held, however, that there had been an absolute sale of
the equipment, that its cost was not recoverable by depletion, and
that the partners were entitled to an allowance for the unrecovered
cost of the equipment transferred. The Commissioner challenged the
latter ruling -- in the Circuit Court of Appeals for the Tenth
Circuit as respects Choate, in the Circuit Court of Appeals for the
Fifth Circuit as respects Hogan. The Commissioner won in the Tenth
Circuit (
Choate v. Commissioner, 141 F.2d 641) and lost in
the Fifth.
Hogan v. Commissioner, 141 F.2d 92. It was to
resolve that conflict that we granted the petition in the present
case limited to that single question.
Page 324 U. S. 3
The Commissioner makes an elaborate argument based on the
assumption that there was no sale of the equipment. The assumption
is that, after the partnership transferred its interest in the
lease, its investment was no longer in the leasehold and equipment
as such, but was an economic interest in an oil producing
enterprise -- an interest which is depletable, since it is measured
by the production of oil. But there are two difficulties with that
argument. In the first place, we find nothing in the Revenue Act of
1938, 52 Stat. 447, or in the Treasury Regulations which provides
for depletion of equipment used in the operation of oil and gas
wells. A deduction is allowed for depreciation by § 23(1) which
permits a "reasonable allowance for the exhaustion, wear and tear
of property used in the trade or business."
And see
Treasury Regulations 101, Art. 23(m)-18. Section 23(m) provides
that, 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"
may be taken as a deduction.
And see Treasury
Regulations 101, Art. 23(m)-10. Depletion is applicable to wasting
assets -- to the exhaustion of natural resources, not of property
used in a business.
See 4 Mertens, Law of Federal Income
Taxation (1942) § 24.02. That distinction between depletion and
depreciation runs through the basis provisions of the Act.
See section 111(a), § 113(a) and (b), § 114(a) and (b).
And the history of the depletion provisions indeed makes clear that
only intangible drilling and development costs, not costs
represented by physical property, are returnable by way of
depletion.
See United States v. Dakota-Montana Oil Co.,
288 U. S. 459; 4
Mertens,
op. cit., § 24.48; Treasury Regulations 101, Art.
23(m)-16(a). In the second place, the Tax Court found that the
parties intended a cash sale of the equipment. That question is
argued here as if it were open for redetermination by us. It is
not. It is the
Page 324 U. S. 4
kind of issue reserved for the Tax Court under
Dobson v.
Commissioner, 320 U. S. 489, and
Wilmington Trust Co. v. Helvering, 316 U.
S. 164,
316 U. S.
167-168. Once a sale of the equipment is conceded, it is
not denied that petitioner is entitled to an allowance for the
unrecovered cost of the equipment transferred. Section 111(a), §
113(a) and (b). No question is presented concerning the allocation
of a portion of the purchase price to the equipment.
Reversed.