*2582 Where the owners of a tract of land had executed an oil and gas lease and subsequent to the execution of the lease and subsequent to the discovery of oil on the premises gratuitously assigned part of the royalty to their children for the term of one year, held, that the donees are not taxable on any part of the royalty received by them.
*485 The above proceedings were consolidated for hearing and decision and involve the following deficiencies in income taxes for the year 1922:
| J. T. Browning | $887.01 |
| C. A. Bryson | 160.54 |
| Mrs. H. L. Lacey | 160.54 |
| M. T. Bryson | 360.54 |
| J. H. McDonald | $127.54 |
| Mrs. S. A. Sillix | 160.54 |
| T. W. Bryson | 160.54 |
Petitioners allege the following errors: (1) That respondent erred in holding that petitioners realized taxable income from the gifts to them of the oil and gas from certain oil-and-gas-producing properties, in that such income was taxable to the donors; (2) that respondent erred in holding that the entire sale price of oil and gas received as a gift was income to the petitioners in that the*2583 fair market value of such oil and gas at the date received should be deducted from such sale price to determine the net income; and (3) the respondent erred in holding that depletion on oil and gas produced from property in which petitioners held an interest acquired by gift was not allowable in that depletion should be allowed on the same basis as if the oil-producing property was in the hands of the donors or the fair market value of the interest in such oil and gas property at the date acquired by petitioners.
The facts were stipulated and in accordance with the stipulation we make the following findings of fact.
FINDINGS OF FACT.
W. J. Bryson and his wife, S. J. Bryson, acquired 160 acres of land in Eastland County, Texas, in the year 1902. The said 160 acres were acquired by the said W. J. Bryson and his wife for the purpose of farming.
*486 Petitioners, with the exception of J. H. McDonald and J. T. Browning, are sons and daughters of W. J. Bryson and his wife. J. H. McDonald and J. T. Browning are their sons-in-law.
At the time the said tract of 160 acres of land was acquired by Mr. and Mrs. Bryson, no oil was being produced within a radius of 50 miles*2584 or more from the same.
Prior to the year 1922, W. J. Bryson and wife executed an oil lease, reserving to themselves a royalty of one-eighth of all the oil, gas or other minerals that might be produced therefrom. On May 13, 1922, oil was discovered and a producing well was brought in. During the year 1922 three more wells were drilled, making a total of four producing wells on the tract of land. During the year 1922, one-eighth of all of the oil produced amounted to 38,844.53 barrels which were sold for $80,780.98.
On May 24, 1922, W. J. Bryson and his wife assigned to each of the petitioners herein an undivided one-sixteenth of their one-eighth retained royalty interest in the oil, gas or other mineral that might be produced from the said 160 acres of land in the year 1922. Such assignments were gifts by the said W. J. Bryson and wife to the petitioners. The material parts of said assignments read:
THE STATE OF TEXAS,
County of Eastland,
That we, W. J. Bryson and wife, S. J. Bryson, of the County of Eastland, State of Texas, for and in consideration of one-dollar, and the love and affection that we have for our children, hereinafter named, Grantees, the receipt*2585 of which is hereby acknowledged and confessed, J. F. Bryson, W. J. Bryson, Jr., C. E. Bryson, Grover Bryson, T. W. Bryson, Miss M. T. Bryson, Miss S. A. Bryson, Miss C. A. Bryson, Miss H. L. Bryson, Mrs. M. O. McDonald & Mrs. D. M. Browning, Grantees; have granted, bargained, sold, conveyed, assigned and delivered and by these presents do grant, bargain, sell, convey, assign, and deliver to the said Grantees, each an individual 1/16 of a 1/8 interest in and to all of the oil, gas, and other minerals in and under, and that may be produced from the following described land for twelve months from the date of this conveyance; The said land situated in Eastland County, Texas, to wit:
* * *
Together with the right of ingress and egress at all times for the purpose of mining, drilling and exploring, said land for oil, gas, and other minerals, and removing the same therefrom.
Said land being now under an oil and gas lease, executed in favor of L. P. Litsinger; it is understood, and agreed that this sale is made subject to the terms of said lease, but covers and includes 1/16 of a 1/8 each of all of the oil royalty, and gas rental of royalty due and to be paid under the terms of said*2586 lease.
It is understood and agreed that 1/16 of a 1/8 each of the money rentals which may be paid to extend the term with which a well may be begun under the terms of said lease is to be paid to the said Grantees, each, and in event that the above described lease for any reason becomes cancelled or forfeited, then and in that event an undivided 1/16 of a 1/8 each of the lease interest, and *487 all future rentals on said land for oil, gas, and other minerals privileges shall be owned by said Grantees, for the said twelve months from the date of this conveyance. Now owning a 1/16 of a 1/8 each, of all oil, gas and other minerals in and under said lands, together with a 1/16 of a 1/8 each interest in all future rents.
The Grantors and Grantees being joint owners in the said mineral interest, it is agreed by and between the Grantees, as part of the consideration of this conveyance, that no one of the said grantees, can sell and convey to a third party the interest herein conveyed except that the Grantors join in the conveyance.
To have and to hold the above described property together with all and singular the rights and appurtenances thereto in anywise belonging unto*2587 the said Grantees, herein their heirs and assigns for the time above mentioned; and we, do hereby bind our heirs, executors and administrators to warrant and forever defend all and singular the said property unto the said Grantees their heirs, and assigns against every person whomsoever lawfully claiming or to claim the same or any part thereof.
Witness our hands this the 24th day of May, 1922.
(Signed) W. J. BRYSON,
S. J. BRYSON.In the year 1922 the petitioners reported the following amounts from the sale of their said one-sixteenth of one-eighth royalty so assigned to them, and took depletion deductions in the following amounts on an alleged discovery value:
| Petitioner | Amount reported | Depletion deducted |
| J. T. Browning | $5,013.75 | $4,000.00 |
| Miss C. A. Bryson | 5,006.75 | 4,500.00 |
| Miss M. T. Bryson | 5,006.75 | 4,500.00 |
| T. W. Bryson | 5,006.75 | 4,500.00 |
| Mrs. H. L. Lacey | 5,006.75 | 4,500.00 |
| Mrs. S. A. Sillix | 5,006.75 | 4,500.00 |
| J. H. McDonald | 5,006.75 | 4,500.00 |
The respondent refused to allow such deductions and such action on the part of the respondent resulted in the deficiencies in controversy.
The depletion deduction which would have been*2588 allowed to W. J. Bryson and his wife based on discovery value if they had not parted with the royalty interests assigned as hereinbefore stated, would have been $26,322.53 on the royalty interests so assigned.
All of the above named petitioners filed their income-tax returns for the year 1922 in the office of the Collector of Internal Revenue for the Second District of Texas within the time prescribed by law.
OPINION.
MILLIKEN: Petitioners' first contention is that under the assignment of May 24, 1922, they acquired no interest in the oil and gas underlying the tract of land which was and still remains the property *488 of the donors; that all they did acquire was an interest in the income from the property and that this income was taxable to the donors alone. The solution of this question depends upon the construction of the contract of assignment. In J. E. Murphy,9 B.T.A. 610">9 B.T.A. 610, we held that the owner of the land possessed a property right in the oil and gas underlying his land, a right which he could convey, and that where he had owned the property for over two years prior to a sale, the sale of such property right constituted a sale of a "capital*2589 asset" within the meaning of section 206 of the Revenue Act of 1921. On the other hand, we held in Henry L. Berg et al.,6 B.T.A. 1287">6 B.T.A. 1287, that an ordinary oil and gas lease was not a sale of oil and gas in place and that oil and gas royalties constituted gross income.
Giving to the contract of gift involved herein a literal interpretation, it would seem that it was a conveyance for the term of one year of part of the donors' interest in the oil, gas and other minerals in and under the land of the donors. If it was a conveyance of a part of the donors' interest in the oil and gas under the land, then the interest conveyed was only 1/16 of 1/8 interest in the minerals, or, in other words, 1/128 interest. It is pertinent to a construction of this paper to take notice of the fact that prior to the date of the gift a lease had been granted and of the further fact that the term of the gift was for only one year, during all of which period the lease was in effect. The immediate purpose and result of the gift was to vest in petitioners undivided interests in the royalty. Taking into consideration the conflicting provisions of the contract of gift, the circumstances under*2590 which it was executed, its immediate result, and the apparent fact that the contract was inartificially drawn, we feel impelled to adopt the construction placed upon it by the parties to these proceedings in their stipulation, which is, "On May 24, 1922, W. J. Bryson and his wife assigned to each of the petitioners herein one-sixteenth of their one-eighth retained royalty in the oil, gas or other mineral that might be produced from the said 160 acres of land in the year 1922."
The initial issue is what the interest of the donors was, a part of which they assigned to petitioners. Did the donors assign a property right which was productive of income, or did they assign income only? If the assignment was of rents, it would fall within the latter classification. The nature of a retained royalty interest in oil and gas was before the Board in Henry L. Berg et al., supra.It was there contended that an oil and gas lease on land in Arkansas constituted a sale of capital "assets" within the provisions of section 206 of the Revenue Act of 1921. This contention we denied. We there said:
The proceeds of minerals, any by minerals we include oil and gas, obtained from*2591 mining operations constitute gross income to the owner of the leased premises, and this is true where the minerals are leased. The result of an *489 ordinary mining lease, such as we have here, is merely to transfer the cost of operations from the owner to the lessee. The operation remains the same and the proceeds of the operation are divided between the lessee and the lessor, the portion of the minerals and amounts paid to the lessor pursuant to the lease usually being termed "royalty." Gross proceeds extracted in the usual course of mining operations have long been considered gross income. Stratton's Independence v. Howbert,231 U.S. 399">231 U.S. 399; Stanton v. Baltic Mining Co.,240 U.S. 103">240 U.S. 103; Von Baumbach v. Sargent Land Co.,242 U.S. 503">242 U.S. 503; United States v. Biwabik Mining Co.,247 U.S. 116">247 U.S. 116.
In Von Baumbach v.Sargent Land Co., cited in the above excerpt, the Supreme Court said:
In the case of State v. Evans,99 Minn. 220">99 Minn. 220, 108 N.W. 958">108 N.W. 958, 9 Ann.Cas. 520, that court, after a review of the English and American cases, said (page 227):
"The propriety of a lease for the purpose*2592 of developing and working mines is recognized by all of the cases, and the rule established by the great weight of authority that such leases do not constitute a sale of any part of the land, and, further, that iron or other materials derived from the usual operation of open mines or quarries constitute the rents and profits of the land, and belong to the tenant for life or years, and to the mortgagor after sale on foreclosure, and before the expiration of the time for redemption. The rule, however, has no application to unopened mines, in the absence of a contract, express or implied, for opening and leasing them."
The same doctrine was held in Boeing v. Owsley,122 Minn. 190">122 Minn. 190, 142 N.W. 129">142 N.W. 129, and in the late case of State v. Royal Mineral Asso.,132 Minn. 232">132 Minn. 232, 156 N.W. 128">156 N.W. 128, in which the decision of the circuit court of appeals in this case, that such leases were merely conveyances of the ore in place, was brought to the attention of the court, and that conclusion expressly denied, the supreme court of Minnesota saying:
"We adhere to the doctrine of the Evans and Boeing Cases, and hold these instruments leases. It follows logically*2593 that the amounts stipulated to be paid by the lessees are rents, and they were expressly held by this court to be rents in the Baeing case, supra, - a case which involved a construction of the very leases now before the Court. They are 'the compensation which the occupier pays the landlord for that species of occupation which the contract between them allows.' Lord Dennison, in Reg. v. Wesbrook, 10 Q.B. 178, 205, 2 New Sess. Cas. 599, 16 L.J.Mag.Cas.N.S. 87, 11 Jur. 515, 22 Eng.Rul.Cas. 623."
In United Statesv. Biwabik Mining Co., also cited in the same excerpt, the Supreme Court said:
In the Sargent Land Company Case it was pointed out that the courts of Minnesota, certainly familiar with the physical characteristics of the ore deposits involved, had in a series of cases held these instruments to be leases, and that the royalties agreed to be paid were rentals in compensation for the privileges granted the lessee. We held the conclusion of the Minnesota courts to be warranted by reason and authority. *2594 242 U.S. 503">242 U.S. 503, and cases cited in margin, page 518.
In John T. Burkett,7 B.T.A. 560">7 B.T.A. 560, we were again confronted with the same question presented in the Berg case, and, following that decision, we again held that an oil and gas lease did not constitute a sale of oil and gas in place even though in addition to the usual royalty there was a cash consideration of $175,000. The Board's decision *490 was affirmed on March 20, 1929, by the Circuit Court of Appeals for the Eighth Circuit, sub. nom. John T. Burkett v. Commissioner of Internal Revenue, 31 Fed.(2d) 667. Among other things, the court said:
Also, this case is ruled by United States v. Biwabik Mining Co.,247 U.S. 116">247 U.S. 116, and Von Baumbach v. Sargent Land Co.,242 U.S. 503">242 U.S. 503. Both of those cases involved taxing statutes. Those cases defined this character of instruments as grants of privileges and not as conveyances of the mineral (iron ore) in place. We cannot see why the character of the instrument is changed or affected by the fact that the mineral is of a character (oil and gas) which was not susceptible of conveyance in*2595 place. In either case, the same rights are given and the same results are intended and do follow. What the landowner could or could not grant does not control the nature of what he did grant.
The rule that such mineral leases, including oil and gas leases, do not constitute a sale of minerals in place, applies in all Federal tax cases irrespective of the construction placed on such leases by state courts. Thus, in the Berg case, after making excerpts from the opinion in the Sargent Land Co. and Biwabik Mining Co. cases, we said:
Upon the other hand, the gross proceeds of minerals extracted in mining operations have been considered gross income without reference to cost since 1913 and all of the Revenue Acts passed since that time and the decisions of the courts have been upon this basis. It thus appears that this theory is one embodied in the Revenue Acts and exists irrespective of what the laws of various States may be relative to mining. (Italics supplied.)
Subsequent to the decision of the Berg case, the United States District Court for the Eastern District of Pennsylvania rendered its decision in *2596 Rosenberger v. McCaughn, 20 Fed.(2d) 179. The facts in that case were that one Weiss, who was the owner of certain coal lands in the Commonwealth of Pennsylvania, in the year 1889 entered into a coal lease covering the lands upon a monthly rental, reckoned on coal raised and prices realized at the breaker. The questions presented were whether this contract resulted in a sale, as of the date of the lease, of all the coal in place, in which case any gain from the sale was not taxable, since the sale was made prior to March 1, 1913; or whether the proceeds from the lease constituted rents, in which case they were taxable as gross income. The court, after pointing out that it was the established law laid down by the courts of Pennsylvania that such a lease resulted in a sale of coal in place, and after referring to the Supreme Court decisions which we cited in the Berg case, said:
The conclusion reached is that the courts of the United States do not accept the Pennsylvania view of "so-called mining leases," and that, in the construction of a tax law of the United States, the law of the state in which the land is situate need not be followed, and that "so-called*2597 royalties" are income.
This decision was affirmed by the Circuit Court of Appeals for the Third Circuit in Rosenberger v. McCaughn, 25 Fed.(2d) 699, and *491 certiorari denied; 278 U.S. 604">278 U.S. 604. To the same effect see John T. Burkett v. Commissioner of Internal Revenue, supra.
From the above it appears that for Federal income-tax purposes ordinary mineral leases, including oil and gas leases, convey no title to minerals in place and that the proceeds of such leases are, in the words of the Supreme Court, "rentals." We are of the opinion that the assignment in this case was of income.
This brings us to the next phase of the case, which is whether the donors, having retained the title to the income-producing property, can relieve themselves wholly or partially of the tax on their income by making an irrevocable gift thereof to others. This is pertinent, since if all rentals arising from a lease result in taxable income to the grantors, none of them are taxable to petitioners. On this question the Board has spoken often and with emphasis. In the late decision in the proceeding of *2598 Julius Rosenwald,12 B.T.A. 350">12 B.T.A. 350, the question presented was whether Rosenwald was taxable on income which he had previously gratuitously assigned to a charity but where he had retained title to and ownership of the income-producing property. Among the assignments was one assigning for a period of five years the interest to become due on a loan and also an assignment for the same period of all the rents accruing under a lease of real property. The borrower and the tenant were notified in writing of the assignments and both agreed in writing to pay to the charity. We make the following excerpt from that opinion:
We come now to the items of interest on a promissory note, rents from certain properties owned by the petitioner and Liberty bond interest purported to have been assigned ro given to the Julius Rosenwald Fund. Since all of the facts are fully set forth in the findings of fact herein, we do not deem it necessary to repeat them here except so far as they may become pertinent to the discussion.
In Ormsby McKnight Mitchel,1 B.T.A. 143">1 B.T.A. 143, the taxpayer was a member of a partnership, having a 51 per cent interest therein, and he entered into*2599 an agreement with his wife, whereby, for a valuable consideration, she should receive one-half of the profits accruing to the taxpayer from that partnership, also that she should be liable to pay him one-half of the losses which might be sustained by reason of his interest in the partnership. It was not contended in that proceeding that his wife thereby became a member of the partnership. The question raised there was whether by virtue of that agreement one-half of the income of the taxpayer covered by the agreement with his wife constituted income to him within the meaning of the taxing statutes. The Board said in that case, "The income from taxpayer's interest in the partnership is first income to him, and no matter how he tries to dispose of it or does dispose of it, it is taxable to him as income from his interest therein." The Board further said, "If the contention made should prevail, the taxing law would be a nullity and an act of Congress imposing taxes made impotent at the will of the taxpayer. If he can escape taxation on one-half the profits of the partnership by agreement, there is no reason why, by another agreement he can not escape taxation on the other half; and*2600 if this taxpayer can do so there is no *492 end to the agreements which may be made, and income as such will cease to be an object of taxation."
In American Telegraph & Cable Co.,2 B.T.A. 991">2 B.T.A. 991, the taxpayer leased all its properties for a certain rental, the lessee to pay the entire rental directly to the stockholders of the lessor as dividends. The taxpayer there contended, inter alia, that none of the payments stipulated in the lease between itself and the lessee constituted income to it. The Board said in holding the income taxable to the lessor, after considering a number of cases cited infra, "The Telegraph Company [meaning lessee] owes and pays rent to the taxpayer. The Telegraph Company is the agent of the taxpayer distributing that rent among its stockholders."
In Samuel V. Woods,5 B.T.A. 413">5 B.T.A. 413, the petitioner owned certain property in fee which was leased to one Stafford and others who subleased to the Big Run Coal Co. That lease provided that the lessee pay certain portions of the rents and royalties as they became due to third persons. The Board said, citing *2601 Rensselaer & Saratoga R.R. Co. v. Irwin,249 Fed. 726; certiorari denied, 246 U.S. 671">246 U.S. 671, "It is clearly authority for taxing the owner in this case where, so far as the records show, he merely designates another to receive his pleasure. Conceded that he did not have actual possession of the amounts so paid, possession is not the determining factor of income even on the cash receipts basis." The Board said further, "Such a voluntary act in anticipation of actual receipt and before the income exists can only affect the income when it actually arises, and in our opinion it may properly be treated as coming to him and immediately disposed of." In the case of Rensselaer & Saratoga R.R. Co. v. Irwin, supra, the corporation leased its properties and agreed that the rental should be paid to its stockholders and bondholders. The taxpayer there contended, as in the instant case, that it did not receive the rents and did not have the right to receive them and consequently the amounts should not be included in its taxable income. The court said:
"It is true that the rent of its road does not go into the plaintiff's treasury and that it*2602 has no means of withholding the tax from it. It is also true that the rent reserved by the lease is paid by the lessee in fixed sums to third parties. All the same, the rent is the property of the plaintiff, and remains such, though by the terms of the lease paid out to others, whose rights are derived through it. While the rent is a debt of the lessee to the lessor, it is as between the lessor and its stockholders, the lessor's income, out of which the dividends, if any, are to be paid.
"The application of the rent under the lease is a mere labor-saving device, the effect being exactly the same as if it be paid to the lessor and by it paid out as far as necessary to bondholders for interest, and the surplus in dividends to its stockholders. The description of the fixed sum to be paid by the lessee of 8 per cent to the lessor's stockholders as a dividend shows that the payment is made as agent of the lessor."
Also see Blalock v. Georgia Ry. & Electric Co.,246 Fed. 387; Anderson v. Morris & Essex R. R. Co.,216 Fed. 83; *2603 West End Street Ry. Co. v. Malloy,246 Fed. 625; Houston Belt & Terminal Ry. Co. v. United States,250 Fed. 1; Boston Terminal Co. v. Gill,246 Fed. 664; Hamilton v. Kentucky & Indiana Terminal R.R. Co.,289 Fed. 20.
In Arthur H. Van Brunt,11 B.T.A. 406">11 B.T.A. 406, we said:
When the instrument is considered as a whole it seems evident that there was an assignment of income from property rather than an assignment of the corpus of such property. The instrument states that a life interest is assigned to the wife so that she is directly entitled to collect only the income from certain *493 securities during the life of the agreement and also the income from any and all leases in which petitioner is the lessor. It further provides that the wife is entitled to collect all other salaries or earnings of petitioner except that from his law firm. Cf. Bing v. Bowers, and Bing v. Anderson, 29 Fed.(2d) 450. Fred W. Warner,5 B.T.A. 963">5 B.T.A. 963. Upon the face of the instrument the Board is of the opinion that the Commissioner correctly held that the rents*2604 and dividends in question constituted income to the petitioner.
See, also, Yale Kneeland,1 B.T.A. 150">1 B.T.A. 150; Alexander S. Browne,3 B.T.A. 826">3 B.T.A. 826; Fred W. Warner,5 B.T.A. 963">5 B.T.A. 963; Alfred Leblanc,7 B.T.A. 256">7 B.T.A. 256; M. C. Garber et al.,11 B.T.A. 979">11 B.T.A. 979; Maud Dunlap Shellabarger,14 B.T.A. 695">14 B.T.A. 695. While all of the above cases are in point, the Rosenwald and Samuel V. Woods cases are on all fours with the instant proceedings in so far as those cases involve the gratuitous assignment of rents from property the title to which the donors retained. The assignments in the above cases were just as binding and irrevocable as the assignment now before us.
Under the above authorities it is our opinion that the rents arising from the oil and gas lease set forth in the assignment were wholly taxable to the grantors and that no part of them was taxable to petitioners.
These proceedings are distinguishable from J. V. Leydig,15 B.T.A. 124">15 B.T.A. 124, and *2605 William I. Paulson,10 B.T.A. 732">10 B.T.A. 732, in that in those cases the assignments had no limited term, whereas the assignment involved in these proceedings is limited to the term of one year, thus disclosing an assignment of no part of the income-producing property, but only of the royalties as they accrued therefrom. They are also distinguishable from those cases involving the assignment of income from trust property such as Edith H. Blaney,13 B.T.A. 1315">13 B.T.A. 1315, and Marshall Field,15 B.T.A. 718">15 B.T.A. 718, in that in those cases the legal title and control of the income-producing property were not in the assignor but in the trustee.
The conclusion which we have reached makes it unnecessary to consider the other contentions made by petitioners.
Reviewed by the Board.
Judgment will be entered under Rule 50.
ARUNDELL and MURDOCK concur in the result.
SIEFKIN, dissenting: It seems to me that the stipulation of the parties in these proceedings that "W. J. Bryson and his wife assigned to each of the petitioners herein one-sixteenth of their one-eighth retained royalty interest in the oil, gas or other mineral that might be*2606 produced from the said 160 acres in the year 1922" does not justify the decision that the assignment was of income. It is at that point of the opinion that a distinction, if any, is to be made *494 between these proceedings and the situation considered in the Leydig and Paulson cases, as well as the Blaney and Marshall Field cases. The distinctions drawn in the prevailing opinion seem to me to be no distinctions at all and constitute an attempt to overrule those cases without saying so. If the subject matter, a royalty interest in an oil and gas lease, is susceptible of present sale, it is clear to me that it may also be the subject of a completed gift and in either case, I believe, the income flowing from the property becomes that of the grantee. That the term is limited makes no difference - that limitation meaning only that a smaller estate is created in the grantee.
TRUSSELL agrees with this dissent.