*2447 1. Mining agreement held to be a sale of coal in place and not a lease.
2. Petitioner expended $2,429.37 during the year 1921, representing the premium paid for insurance on labor used in the development of a coal mine. Held that this amount was a capital expenditure.
3. Petitioner expended $1,700 in recovering and repairing a steam shovel during 1921 which had fallen over an embankment. Held that the amount paid was an ordinary and necessary business expense and is deductible for the year 1921.
*1135 The Commissioner determined deficiencies in income and profits tax of $5,166.77, $11.45, and $4,813.33 for the fiscal years ending August 31, 1921, 1922, and 1923, respectively. The petitioner assigns error on the part of the Commissioner (1) in failing to allow as a deduction from gross income an amount of $31,000 paid "as a minimum royalty" during each of the years in question; (2) in failing to allow as a deduction from gross income in the taxable year 1921 an amount of $2,429.37 paid for employees' compensation insurance*2448 during the year; (3) in failing to allow as a deduction from gross income an amount of $1,700 paid for recovering and repairing a steam shovel which had fallen over an embankment in the taxable year 1921.
FINDINGS OF FACT.
Petitioner is a Pennsylvania corporation with principal office at Pittsburgh. It was incorporated August 18, 1920, with an authorized capital stock of $200,000 par value, which was later increased to $400,000 par value.
Petitioner acquired the coal brokerage business of the Lindley Coal Co. and opened its books of account on September 1, 1920. On that date, also, it entered into an agreement with T. A. Miller and Ella S. Miller, his wife, of Jefferson Township, Washington County, which agreement provided in part as follows:
NOW THIS AGREEMENT WITNESSETH: That the said lessors, for and in consideration of the royalties and covenants hereinafter mentioned and reserved on the part of the said lessee, to be paid, kept and performed, have demised, leased and let, and do hereby demise, lease and let unto the said lessee, for and during the term of ten (10) years from the date hereof, the right and privilege to mine and remove.
*1136 All that coal*2449 of the Pittsburgh or River Vein covered by Fifteen (15) feet or more of earth, in and under all those five certain tracts of land situate partly in Jefferson and party in Independence Townships, Washington County, Pennsylvania, separately bounded and described as follows: -
* * *
In consideration of the rights and privileges hereby leased, the lessee, for itself, its successors and assigns, covenants and agrees to and with the said lessors, their heirs, executors, administrators and assigns, as follows:
1. The minimum amount of coal that shall be mined and removed by the lessee under this lease, during each year of the term of this lease, shall be two hundred fifty-eight thousand three hundred thirty-three and one-third (258,333 1/3) tons run of mine, and the said lessee agrees to pay the royalty hereinafter provided for on said minimum tonnage at the times hereinafter specified, whether said tonnage is mined or not.
2. The said lessee shall and will pay to the said lessors on the first day of September 1921 and annually thereafter on the first day of September of each year during the term of this lease twelve (12) cents per ton run of mine for each and every ton of coal*2450 mined during each year of the term of this lease (a ton to be computed at two thousand (2000) pounds to the ton) and the minimum tonnage to be mined in each year as provided for in the preceding paragraph shall be paid for at the times aforesaid whether mined or not; that is to say the amount of royalty to be paid on the first day of September 1921, and annually thereafter on the first day of September of year during the term of this lease and on the first day of September 1930, shall not be less than thirty-one thousand ($31,000.00) Dollars each year.
* * *
7. And the said lessee agrees to pay the royalties above mentioned and agreed upon regardless of the quality or character of said coal and regardless also of its location or availability or mining condition and the said lessee shall and will pay said royalties on the basis of not less than Four thousand five hundred thirty-two (4,532) tons per acre even though that amount is not recovered.
8. And it is further agreed that if the said lessee shall fail to pay the royalties herein reserved, or any part thereof, at the times and in the manner above mentioned, or shall fail to comply with any of the other covenants, terms*2451 and conditions of this lease, and shall continue such default or defaults for the space of thirty (30) days, the said lessors may at their option, in addition to other remedies, provided by law, forfeit, cancel and make void this lease, provided they first give to the lessee, its successors or assigns, notice in writing of their intention to declare such forfeiture, and at the expiration of thirty days after the date of service of such notice, this lease shall thereupon, without further action on the part of the said lessors, be forfeited, cancelled and void, unless within said period of thirty days the said lessee shall pay the royalties so in default and comply with the other covenants, terms and conditions of this lease in the performance of which the said lessee was in default. In case of forfeiture, the lessors may re-enter upon the said premises and hold the same as if this lease had not been executed, without prejudicing or affecting any claim that they may have for unpaid royalties or for damages that said lessors may sustain for any breach by the lessee of the covenants, terms and conditions of this lease.
9. Upon the expiration of this lease if all the royalties reserved*2452 and to be paid annually on the first day of September, 1921, and annually thereafter on the first day of September of each year during the term of this lease and on *1137 the first day of September, 1930, amounting in all to three hundred ten thousand ($310,000) Dollars, shall have been paid, or at any time before the expiration of this lease if and when royalties amounting to three hundred ten thousand ($310,000) Dollars, shall have been paid, provided this lease has not been forfeited under the terms above mentioned, the said lessors shall and will for and in consideration of the additional sum of One ($1.00) Dollar execute and deliver to the lessee, its successors and assigns a deed in fee simple, clear of all encumbrances, for all the unmined coal of the Pittsburgh or River Vein covered by Fifteen (15) feet or more of earth in and under the aforesaid tracts of land, together with all the mining rights as hereinabove mentioned.
The mine was first operated under the agreement as a stripping mine and approximately 400 tons of coal had been removed by the petitioner when it discovered that the mine could not be profitably operated under the stripping process. Thereupon, *2453 the petitioner abandoned that process and proceeded with the development so that the coal might be taken from a drift. No coal was mined under the new process during the fiscal year ended August 31, 1921, but coal was so mined during the other taxable periods here involved and in the following amounts: The fiscal year ending August 31, 1922, 33,010 tons; the fiscal year ending August 31, 1923, 176,796 tons. Approximately one-half the tonnage taken out during the year ending August 31, 1923, has been mined in each year thereafter and the petitioner has continued in all years to make the minimum annual payment of $31,000. The agreement or contract has not been canceled by either party.
In accordance with the terms of said agreement, petitioner paid $31,000 as a minimum payment to the said T. A. Miller and wife in each of the respective years here involved and showed said amount as a deduction in each of the respective tax returns against gross income from other operations than the mine in question. The respondent has disallowed said deductions but has allowed as deductions from income under the designation of "Depletion or advanced royalties," as follows:
| Fiscal year ended - | Tons mined | Deduction from income at 12 cents per ton |
| Aug. 31, 1921 | None. | None. |
| Aug. 31, 1922 | 33,010 | $3,961.20 |
| Aug. 31, 1923 | 176,796 | 21,215.52 |
| Aug. 31, 1924 | 85,379 | 10,245.48 |
*2454 Respondent has capitalized the balance of said annual payments of $31,000 as follows:
| Year ended August 31, 1921 | $31,000.00 |
| Year ended August 31, 1922 | 27,038.80 |
| Year ended August 31, 1923 | 9,784.48 |
| Year ended August 31, 1924 | 20,754.52 |
During the fiscal year ended August 31, 1921, petitioner paid the Pittsburgh & West Virginia Railroad Co. the amount of $1,700 for recovering and repairing a steam shovel which had been used by the petitioner to build a spur track to the mine but went over an embankment and fell into the creek below. It is the contention of the respondent that such payment for recovering and repairing the steam shovel was a capital expenditure incurred in the development of the mine. It is the contention of the petitioner that such payment is deductible from gross income for 1921.
During the fiscal year ended August 31, 1921, petitioner paid $2,429.37 for compensation insurance under the laws of Pennsylvania to insure the liability for accident to mine employees of the petitioner engaged upon the development*2455 operations of petitioner. Respondent treated said payment as a capital expenditure incurred in connection with the mining development and disallowed the deduction. Petitioner contends that said payment is the equivalent of damages which the petitioner would have been obliged to pay in the event of accidents and constituted an ordinary and necessary expense.
OPINION.
LITTLETON: In each of the years under consideration the petitioner, under the provisions of the instrument set out in the findings of fact, paid to T. A. Miller and his wife, Ella S. Miller, the sum of $31,000. These payments, the petitioner contends were rentals or other payments required to be made as a condition to the continued use or possession of the property which is the subject matter of the instrument heretofore referred to, and, as such, constitute proper deductions from the gross incomes of the years concerned. The respondent has allowed a deduction for each year, in an amount equal to the product of the number of tons of coal removed during the year multiplied by 12 cents, holding that the sums paid in excess of such amounts "are a part of the expense of developing the plant or mine, and as such are*2456 capital expenditures" and not proper deductions from gross income.
The question thus presented to us depends for its solution upon the construction to be placed upon the agreement under which the payments were made. This proceeding was submitted upon a written stipulation of facts which makes no reference whatever to the circumstances surrounding the parties when the agreement was made, or to the construction given the agreement by the parties themselves. Hence, in determining whether the agreement is a lease or creates a relation other than that of lessor and lessee, we must ascertain the intent of the parties entirely from the agreement itself.
*1139 Though the use of words ordinarily used in a lease is to be given weight in arriving at the intent of the parties, such use is not conclusive. The use of technical words or phrases which have a definite legal signification can not defeat the intent of the parties if that intent is manifest from the whole agreement. So that the words "demise," "lease," "let," "lessors," and "lessee," and like words, specially appropriate to a contract between the owner and tenant for years, have no bearing whatever if the agreement is*2457 not in fact a lease. Nor is the character of the agreement affected by the contractural provisions that in case of nonpayment of "royalties" the grantors shall have the right of distress, or at their option, the right of forfeiture of the grant. The stipulated remedies are consistent with either a sale or a lease.
In the agreement under consideration the operative words are "demise," "lease," and "let," which signify to grant the temporary possession of the subject; and the parties have styled themselves "lessors" and "lessee." The entire agreement is couched in terms and phrases appropriate to a contract between the owner and tenant for a term of years, which give to the agreement all the appearances of a lease. But when all parts of the agreement are read as a harmonious whole, the intent of the parties is clearly disclosed to have been a purchase and sale of coal in place; and the form of agreement adopted to accomplish the purposes of the parties was undoubtedly a matter of the most convenient manner of securing to the grantors the greatest degree of security for the payment of the purchase price.
The sum and substance of this agreement is that the grantors have sold all*2458 of the coal, in place, underlying the described premises to the petitioner, for a consideration of $310,000, on a deferred-payment basis. That conclusion is inescapable. The agreement provides that when the petitioner shall have paid "royalties" amounting to $310,000, the lessors shall, in consideration of the additional sum of $1, execute and deliver to the petitioner a deed in fee simple for all of the unmined coal. There is no escape by the petitioner from the payment of the fixed sum, unless it be by way of operation of the forfeiture provisions of the agreement. If it has not paid "royalties" amounting in all to $310,000 before the end of the term fixed by the agreement, it will have done so by the end of the term. Even if the petitioner had not mined and removed an ounce of coal, by the end of the term of the agreement it will have paid the entire stipulated price, for it has bound itself to make an annual minimum payment of $31,000 for a term of ten years, and when it shall have complied with the covenants of the agreement in that respect, it will be entitled to receive a deed in fee simple for all of the unmined coal. Furthermore, as we construe the contract, the petitioner*2459 is obligated to pay *1140 the price of $310,000, irrespective of the total quantity of coal recovered and even though the product of the total number of tons recovered multiplied by the "royalty" rate of 12 cents per ton amounts to a lesser sum. Such is the purport of the provision that the petitioner "agrees to pay the royalties above mentioned and agreed upon regardless of the quality or character of said coal and regardless of its location or availability or mining condition and the said lessee shall and will pay said royalties on the basis of not less than four thousand five hundred thirty-two (4,532) tons per acre even though that amount is not recovered." These provisions of the agreement upon which we have commented are entirely foreign to an actual lease, and disclose the true nature of the agreement to be a sale rather than a lease.
By our conclusions as to the nature of the agreement under which the payments of $31,000 were made in each of the years under consideration, we are constrained to hold that such payments were payments on the purchase price of all the coal in place, and, as such, represent capital expenditures and are not proper deductions from gross*2460 income. In each of the years before us, the respondent has allowed deductions for "Depletion or advanced royalties," and the petitioner has presented no proof that it is entitled to any greater deductions than those allowed by the respondent.
During the fiscal year ending August 31, 1921, the petitioner had not reached the state of productive operation of the mine, but then was engaged in the development of the property. It first attempted to operate the mine by the stripping process, which it abandoned as uneconomical after removing a negligible amount of coal, and then began the development of the property as a drift mine, no coal being mined by the new process during this year. The expenditures for labor by petitioner in this instance, as well as for materials employed in the development of mining property, are capital expenditures and are not deductible as expenses from gross income. . Pursuant to the laws of Pennsylvania, petitioner insured itself against liability for accident to its mine employees and during the fiscal year 1921 paid premiums of $2,429.37 for such compensation insurance. This insurance was incident*2461 to the labor employed and its cost properly is an element of the labor cost. Since the mine was in process of development in 1921 and expenditures for labor employed in the development of mining property are capital expenditures, this expenditure for employees' compensation insurance is likewise, in this instance, a capital expenditure and is not deductible as expense from the gross income of that year. Accordingly, we approve the determination of the respondent on this issue.
*1141 The last item in controversy concerns the deductibility of an item of $1,700 expended in 1921 in recovering and repairing a steam shovel used by the petitioner to build a spur track to the mine which shovel had fallen over an embankment into a creek. The Pittsburgh & West Virginia Railroad Co. recovered the shovel and made certain repairs to it for which the petitioner, on November 29, 1920, paid the railroad company $1,700. The cost of raising the steam shovel from the creek bottom to its position on the railroad track and repairs thereto necessitated by the damage resulting from its fall into the creek, were ordinary and necessary expense. *2462 . Accordingly, we hold that respondent erred in refusing to allow the deduction of this loss for the fiscal year 1921.
Reviewed by the Board.
Judgment will be entered under Rule 50.