*1606 Certain oil and gas leases were transferred to petitioner by assignments. In each instance the consideration was a stated amount of money to be paid by petitioner partly in cash and partly out of oil and gas as produced from the leased property. Held, the deferred payments out of oil and gas were not royalties, but were capital transactions, not deductible as expenses.
*688 This proceeding is for the redetermination of a deficiency in income tax, asserted by the respondent for the year 1923 in the amount of $96,579.88. The error alleged is that the respondent treated, as capital investment, payments made by petitioner out of the proceeds of oil and gas produced from certain leases.
FINDINGS OF FACT.
The petitioner is a corporation, with its principal office in St. Louis, Mo. It is engaged in the production of oil and gas and in the acquisition of oil and gas leases.
*689 On July 26, 1921, the Godelline Oil Corporation and Errett R. Newby, owners of a certain oil and gas lease, transferred that lease to the petitioner by an*1607 instrument duly signed and acknowledged. That instrument contained the following provisions:
WHEREAS, on the 26th day of July, 1921, a certain oil and gas mining lease was made and entered into by and between caswell C. Endicott and Laura A. Endicott, husband and wife, Lessors, and the Marland Refining Company, a corporation, Lessee, covering the following described land in the County of Kay, State of Oklahoma, to-wit:
* * *
said lease being recorded in the office of the County Clerk in and for said County in book 46 at page 36; and
WHEREAS, the said lease and all rights thereunder or incident thereto are owned by the Godelline Oil Corporation, of Oklahoma, an undivided one-half interest, and Errett R. Newby, an undivided one-half interest;
NOW THEREFORE, For and in consideration of the sum of Fifty Thousand ($50,000.00) Dollars in hand paid to the assignors herein by the Comar Oil Company, assignee hereunder, the receipt of which is hereby acknowledged, and the additional sum of One Hundred Thousand Dollars ($100,000.00) net to be paid out of the oil and gas as hereinafter set out, the undersigned, the present owners of said lease and all rights thereunder or incident thereto, *1608 do hereby bargain, sell, transfer, assign and convey unto the COMAR OIL COMPANY, all of the right, title and interest of the original lessee and present owners in and to the said lease and rights thereunder, in so far as it covers the following described lands, to-wit:
* * *
together with all personal property used or obtained in connection therewith to the COMAR OIL COMPANY and its successors and assigns.
The above mentioned sum of $100,000.00 net shall be paid to the assignors herein out of one-eighth of the gross production of oil and gas produced from said property, by the assignee or its assigns, * * *
It is understood that a lien is hereby retained by first parties on said one-eighth of the oil and gas until said sum of $100,000.00 is paid.
And for the same consideration, the undersigned for themselves and their heirs, successors and assigns, do covenant with the said assignee, its successors or assigns, that they are the lawful owners of the said lease and rights and interests thereunder and of the personal property thereon or used in connection therewith; that the undersigned has good right and authority to sell and convey the same and that all rentals and royalties*1609 due and payable thereunder have been duly paid.
IN WITNESS WHEREOF, The undersigned owners and assignors have signed and sealed this instrument this 15th day of July, 1922.
On October 5, 1922, Henry Rosenthal, owner of a certain oil and gas lease, conveyed that lease to the petitioner by an instrument, duly signed and acknowledged, containing the following clause:
* * *
That the first party hereto has this pay bargained, sold and assigned and transferred to second party hereto, all of his interest in the said oil and gas lease upon said lands hereinabove described, same being an undivided one-fourth interest, for the consideration of One Hundred Thousand Dollars *690 ($100,000.00) cash and Fifty Thousand Dollars ($50,000.00) to be paid to the party of the first part by party of the second part out of one-half of their portion of the first oil or gas produced, same to be made when and as the oil is sold.
* * *
On November 20, 1922, a written agreement was entered into between the Alcorn Oil Company and the petitioner, whereby the Alcorn Oil Company assigned to petitioner three designated oil and gas leases. The pertinent provisions of the agreement read:
* * *1610 *
THIRD: The party of the second part agrees to pay for said three leases the sum of Three Million Dollars ($3,000,000.00); One Million Seven Hundred Fifty Thousand Dollars ($1,750,000.00) shall be paid in cash upon the approval of titles as above provided, the balance, amounting to One Million Two Hundred Fifty Thousand Dollars ($1,250,00.00) shall be paid by Comar out of fifty per cent. (50%) of the oil produced as represented by the working interest in said properties. The title to all of the working interest in the oil produced from said properties subsequent to the date of this agreement shall be in Comar Oil Company, and as oil is produced Comar Oil Company shall pay to the Alcorn Oil Company sums of money equivalent to the value of Fifty per cent (50%) of the oil produced, as aforesaid. * * *
All the leases above mentioned were, at the times when acquired by petitioner, located in unproven and undeveloped territory, although drilling operations had been started on some of the leased lands.
Pursuant to the terms of the above mentioned instruments, petitioner paid during 1923, out of proceeds from oil and gas produced from said leased territories, the following amounts: *1611
| To Godelline Oil Corporation | $100,000.00 |
| To Henry Rosenthal | 43,104.02 |
| To Alcorn Oil Company | 1,247,001.22 |
| 1,390,105.24 |
In its income-tax return for 1923 all amounts collected from the sale of oil and gas produced were included in gross income by the petitioner, who treated the above payments as capital expenses and made no deduction respecting them. The respondent accepted that treatment of those expenditures, but disallowed $1,107,487.69 of the amount claimed by the petitioner as a depletion deduction.
It is conceded by petitioner that, if its payments in 1923 on account of the leases, amounting to $1,390,105.24, are capital transactions, then the respondent's determination as to depletion deductions is correct.
All of the leased oil lands involved were located in Oklahoma, and each instrument in question was executed according to the requirements in that State for executing conveyances of interests in land.
*691 OPINION.
MARQUETTE: The petitioner's contention is that the amounts paid by it in 1923 out of oil produced, with respect to the previously purchased oil leases, did not constitute a capital investment; that such amounts did not*1612 represent income at all to the petitioner, but were in reality merely deliveries to petitioner's assignors of royalties reserved to such assignors in the contracts assigning the leases; and, hence, such amounts are not properly taxable to the petitioner.
We can not agree with that contention. The terms of the various assignments of leases effected absolute conveyances to the petitioner of the entire interests owned by the respective assignors, none of whom made any reservation of royalties. A royalty, as to minerals, is a rent reserved. Here, the grantor sold and the petitioner bought mineral rights for definite, fixed considerations which were to be met, in part, by deferred payments out of minerals if, as, and when produced from the leased lands. Such payments in our opinion do not constitute rentals or royalties for the use of the property.
This Board has decided adversely to the petitioner's contention, in several proceedings wherein the factual conditions were substantially the same as those now under consideration. Cf. *1613 ; affd., ; ; affd., ; ; ; affd., . In the Pugh case, supra, Pugh executed an instrument purporting to sell one-half of his royalty interest in an oil lease for a stated consideration which was to be paid partly in cash and the balance "out of the one-half royalty herein conveyed." The instrument was held to be a contract of sale which divested Pugh of his property rights so conveyed. The other cases above cited were to like effect. All of them are directly in point with the present instance and the principle which they announce is, we think, controlling here. We find no error in the respondent's determination.
Judgment will be entered for the respondent.