*73 Decision will be entered for the petitioner.
Petitioner entered into an option agreement whereby it granted to a mining corporation sole option to purchase certain mining claims for the total purchase price of $ 500,000. Petitioner agreed to place instruments of title in escrow to be delivered to the mining corporation upon final payment of the purchase price. Prior payments were to be set off against the purchase price. The balance was to be paid in annual installments of $ 25,000. In addition, petitioner was to receive, each year, a royalty of 5 per centum of all net returns from production in excess of $ 400,000. These royalty payments were to be applied so as to reduce the last installment due. Held, the transaction constituted the sale of a capital asset.
*1360 Respondent determined deficiencies in petitioner's income and excess profits taxes as follows:
| Year ended Nov. 30 -- | Kind of tax | Deficiency |
| 1952 | Income and excess profits | $ 5,103.12 |
| 1953 | Income and excess profits | 5,103.12 |
| 1954 | Income and excess profits | 4,620.04 |
| Period | ||
| Dec. 1, 1954 | ||
| to | ||
| Aug. 23, 1955 | Income | 812.00 |
| 15,638.28 |
*1361 The sole question is whether all or any part of the moneys received by petitioner under the terms of an option agreement were proceeds from the sale of a capital asset.
FINDINGS OF FACT.
Some of the facts are stipulated, the stipulation being incorporated herein by this reference.
Petitioner is an Idaho corporation, having its only office in Twin Falls, Idaho.
Prior to November 22, 1944, petitioner owned 21 patented and 23 unpatented mining claims, and other lands situated*75 near the town of Patterson, Idaho, together with buildings, machinery and equipment, water rights, appurtenances, and certain warehouse inventories of materials and supplies. These properties will hereinafter sometimes be collectively referred to as the Ima Mine or the Ima group.
Prior to November 22, 1944, petitioner prospected, developed, and produced hubernite ores containing tungsten trioxide (WO[3]) from the downward dip of several veins which apex within the boundaries of four of the unpatented claims.
On November 22, 1944, petitioner entered into an option agreement with Bradley Mining Company, sometimes hereinafter referred to as Bradley, a large producer of mercury, gold, antimony, and tungsten. Thereafter, petitioner and Bradley entered into agreements supplementing and modifying the option agreement of November 22, 1944. The first of these supplemental agreements was dated December 19, 1944, 1 the second, January 4, 1945, and the third, December 26, 1945.
*76 The Tungsten Mining Corporation, hereinafter referred to as Tungsten, was the owner of certain mining claims known as the Mazda group. These claims adjoined the Ima group of claims.
On January 18, 1946, petitioner, Bradley, and Tungsten entered into a boundary agreement providing that, during the period of operations by Bradley, the ownership of ore deposits within the Ima and Mazda groups should be determined by vertical boundaries.
On February 18, 1946, Bradley consummated a lease option agreement with Tungsten covering the Mazda group. It was agreed that ore extracted from the Mazda group could be trammed through the Ima properties. Bradley did not surrender or release its option to purchase the Mazda group and during the period here involved held exclusive possession and peaceful enjoyment of the Mazda properties, prospecting, developing, and mining tungsten trioxide ores therefrom.
*1362 On April 1, 1946, petitioner and Bradley entered into a new "Option Agreement," stating that they desired certain changes, additions, and modifications to the agreement of November 22, 1944, and supplements thereto, and that they desired to enter into an agreement finally expressing the*77 understanding and agreement between them.
The prior agreements and negotiations between petitioner and Bradley were merged into the new agreement, and the new agreement was to be construed without reference to any of the former agreements or negotiations.
The new agreement contained 14 "whereas" clauses reciting, inter alia, that petitioner owned certain mining properties and had entered into earlier agreements with Bradley relative to these properties; that petitioner had received from Bradley, under the terms of the prior agreements, $ 15,000 for supplies and $ 95,000 to be applied on the purchase price of petitioner's property; that Bradley had an agreement with Tungsten to conduct mining operations on the Mazda group of mining claims; that petitioner, Bradley, and Tungsten had entered into an agreement providing that the ownership of ores within the Ima and Mazda groups of mining claims should be determined by vertical boundaries; and that Bradley was willing to pay to petitioner any royalties required under the terms and conditions of the agreement on net returns for minerals abstracted not only from the Ima, but also the Mazda group of mining claims, in consideration for*78 an extension by petitioner of the time of payment of the purchase price for the Ima property.
Paragraph I of the agreement provided that --
IMA does hereby give, grant and accord unto BRADLEY the sole and exclusive right and option under the terms and conditions of this agreement to enter in and upon, and to mine and extract any and all minerals and mineral substances found and developed in, and also gives, grants and accords unto BRADLEY the sole and exclusive right and option to purchase and acquire, under the terms hereof, all the right, title and interest of IMA in and to the following described mining claims and property, and the whole thereof, * * *
The agreement applied to 44 specified mining claims, as well as all other mining claims and grounds of every kind and character situated in Lemhi County, Idaho, in which petitioner had or thereafter acquired any interest. It also applied to the personal property belonging to petitioner situated on the described property or used in connection therewith, together with all millsites, water rights, power plants, licenses, easements, tailraces, tailing sites, and tailing dams or easements then owned or which might be acquired by petitioner*79 for use in connection with the mining claims.
The agreement provided for a total purchase price of $ 500,000, to be paid as follows:
(1) For the total purchase price of FIVE HUNDRED THOUSAND DOLLARS ($ 500,000.00) -- said purchase price to be paid as follows:
*1363 (a) Payment of $ 75,000.00 on said purchase price of said IMA property, and $ 15,000.00 for certain tools, equipment, furniture and fixtures as described in that certain bill of sale dated December 19, 1944, which bill of sale has heretofore been delivered by IMA to BRADLEY (which bill of sale did not include any of the equipment and property described in the bill of sale now in escrow with the Fidelity National Bank, Twin Falls, Idaho, and the inventory and appraisal hereto attached as Exhibit "A") and supplies thereon -- receipt of which payments is hereby acknowledged by IMA (and in this connection IMA has agreed to deliver, and has delivered to BRADLEY the sole and exclusive possession of said IMA property -- possession thereof by BRADLEY to be retained so long as it complies with the terms and conditions of this agreement);
(b) Payment of $ 20,000.00 on or before the 1st day of February, 1946, receipt of which*80 payment is also hereby acknowledged by IMA;
(c) Payment of $ 25,000.00 on or before the 1st day of April, 1946, receipt of which payment is also hereby acknowledged by IMA, and the payment of $ 25,000.00 on or before the 1st day of April of each year thereafter until said purchase price has been paid in full -- it being agreed that deferred payments shall not bear interest; the unpaid balance of said purchase price for said property now being the sum of $ 380,000.00
(2) BRADLEY shall, in the event the net returns as herein defined, from all metals, minerals, ores and values from the above described IMA property, and also upon all of the net returns from all metals, minerals, ores or values extracted by BRADLEY from the aforesaid adjoining MAZDA Group of mining claims * * * exceed the sum of $ 400,000.00 in any one year (April 1st of one year to Midnight March 31st of the next year), BRADLEY shall pay to IMA, in addition to said $ 25,000.00 annual installment, five per cent (5%) of the amount of such net returns in excess of said $ 400,000.00, which payment shall apply on the last annual installment then unpaid on the purchase price of the above described property; and any and all*81 payments made to IMA hereunder, whether as royalty payments or as annual payments, or otherwise, shall apply on the purchase price of the above described property.
(3) BRADLEY shall make the aforesaid royalty payments to IMA by depositing the same with the Escrow Holder named herein to IMA's account on or before the 20th day of April following the termination of any year wherein the net returns are in excess of $ 400,000.00, and, whether BRADLEY shall be required to make such royalty payment in any one year under the provisions hereof, BRADLEY shall send a statement to IMA on or before said date showing the amount of money received by BRADLEY from the sales of products from the properties described in Subdivision TWO (2) above, and a statement of marketing charges.
Petitioner required that royalty payments be made on production from Mazda as well as from its own properties because it did not want to have its tunnelways and equipment used by Bradley to mine out the Mazda group without having some protection insofar as its contract with Bradley was concerned.
Bradley agreed, among other things, to pay the real and personal property taxes assessed against the property and to perform *82 the required annual assessment work on the unpatented mining claims. These obligations were subject to Bradley's right to surrender its option and be relieved from proceeding thereunder.
*1364 Petitioner and Bradley agreed that petitioner had deposited in escrow copies of the option agreement of November 22, 1944, and supplemental agreements thereto; a bill of sale for machinery, tools, and equipment; and a mining deed and abstracts of title for all the property demised. Petitioner further agreed to deposit a copy of the April 1, 1946, option agreement in escrow, to instruct the escrow holder to deliver all the above instruments to Bradley when Bradley had completed the payments provided for, to pay and discharge all liens on the property and all debts which might become liens on the property, to protect the title to the property, and to permit Bradley to have full and complete management and operation of the property.
Bradley could elect to abandon the agreement and be released from its terms. In such case it was to give petitioner 30 days' written notice, pay all royalties due, pay petitioner for certain tools, pay certain real and personal property taxes, pay the escrow *83 holder $ 250, and surrender possession of the property to petitioner. Bradley could not elect to abandon the agreement or be released from its terms so long as it owned, possessed, or controlled the Mazda group of mining claims.
On April 1, 1946, the date of the option agreement, petitioner and Bradley entered into an escrow agreement and petitioner placed all instruments required to convey title to all of the Ima property with an escrow holder.
Pursuant to the provisions of the option agreement Bradley remained on petitioner's properties, in exclusive possession thereof, and explored for, developed, and produced ores and concentrates of tungsten trioxide.
Bradley performed all obligations imposed upon it under the terms of the option agreements, and made payments to petitioner in the amounts and at the times shown in the following schedules:
| Performances under agreements prior to April 1, 1946: | ||
| Cash consideration paid for option Nov. 21, 1944 | $ 500.00 | |
| Amount to be paid pursuant to agreement | 500,000.00 | |
| First cash payment Jan. 5, 1945 | $ 90,000 | |
| Portion applicable to materials and supplies | 15,000 | 75,000.00 |
| Balance receivable Jan. 5, 1945 | 425,000.00 | |
| Payments Jan. 5, 1945-Jan. 1, 1946 | 20,000.00 | |
| Balance receivable Jan. 30, 1946 | 405,000.00 | |
| Payment Mar. 31, 1946 | 25,000.00 | |
| Balance receivable, Jan. 1, 1946, under reformed agreement | 380,000.00 | |
| Amount paid as accruals under prior contracts | 340.30 | |
| Balance receivable under terms of reformed agreement of Jan. 1, | ||
| 1946 | 379,659.70 |
*84 *1365 Performances Under Basic Agreement of April 1, 1946, and Supplemental Agreements Thereto
| Gross Production by Bradley Mining Co. | |||
| Period | |||
| Fixed | Tons from Ima | ||
| annual | per cent | ||
| payment | |||
| Prior to Taxable Years Involved: | |||
| Apr. 1, 1946 | |||
| Apr. 1, 1946-Mar. 31, 1947 | $ 25,000 | 87.51 | 23,717 |
| Apr. 1, 1947-Mar. 31, 1948 | 63.89 | 10,001 | |
| Apr. 1, 1948-Mar. 31, 1949 | 25,000 | 45.94 | 3,997 |
| Apr. 1, 1949-Mar. 31, 1950 | 25,000 | 71.59 | 20,563 |
| Apr. 1, 1950-Mar. 31, 1951 | 25,000 | 92.82 | 23,289 |
| During Taxable Years Involved: | |||
| Apr. 1, 1951-Mar. 31, 1952 | 25,000 | 61.46 | 27,378 |
| Apr. 1, 1952-Mar. 31, 1953 | 25,000 | 30.46 | 14,732 |
| Apr. 1, 1953-Mar. 31, 1954 | 25,000 | 10.48 | 5,556 |
| Apr. 1, 1954-Mar. 31, 1955 | 25,000 | 12.73 | 7,692 |
| Gross Production by Bradley Mining Co. | |||
| Period | |||
| Tons from Mazda | Total dollars | ||
| per cent | cash receipts | ||
| basis | |||
| Prior to Taxable Years Involved: | |||
| Apr. 1, 1946 | |||
| Apr. 1, 1946-Mar. 31, 1947 | 12.49 | 3,386 | $ 236,014.38 |
| Apr. 1, 1947-Mar. 31, 1948 | 36.11 | 5,652 | 137,204.60 |
| Apr. 1, 1948-Mar. 31, 1949 | 54.06 | 4,704 | 158,941.45 |
| Apr. 1, 1949-Mar. 31, 1950 | 28.41 | 8,161 | 217,000.93 |
| Apr. 1, 1950-Mar. 31, 1951 | 7.18 | 1,803 | 531,489.33 |
| During Taxable Years Involved: | |||
| Apr. 1, 1951-Mar. 31, 1952 | 38.54 | 17,168 | 1,341,165.20 |
| Apr. 1, 1952-Mar. 31, 1953 | 69.54 | 33,633 | 1,313,239.80 |
| Apr. 1, 1953-Mar. 31, 1954 | 89.52 | 47,462 | 1,691,882.00 |
| Apr. 1, 1954-Mar. 31, 1955 | 87.27 | 52,714 | 1,740,104.88 |
| Payments of | |||
| Period | 5% of production | ||
| in | Total | Balance end | |
| excess of | payments | of period | |
| $ 400,000 | |||
| Prior to Taxable Years Involved: | |||
| Apr. 1, 1946 | $ 379,659.70 | ||
| Apr. 1, 1946-Mar. 31, 1947 | $ 25,000.00 | 354,659.70 | |
| Apr. 1, 1947-Mar. 31, 1948 | 354,659.70 | ||
| Apr. 1, 1948-Mar. 31, 1949 | 25,000.00 | 329,659.70 | |
| Apr. 1, 1949-Mar. 31, 1950 | 25,000.00 | 304,659.70 | |
| Apr. 1, 1950-Mar. 31, 1951 | $ 6,574.42 | 31,574.47 | 273,085.23 |
| During Taxable Years Involved: | |||
| Apr. 1, 1951-Mar. 31, 1952 | 47,058.26 | 72,058.26 | 201,026.97 |
| Apr. 1, 1952-Mar. 31, 1953 | 45,661.99 | 70,661.90 | 130,364.98 |
| Apr. 1, 1953-Mar. 31, 1954 | 64,594.10 | 89,594.10 | 40,770.88 |
| Apr. 1, 1954-Mar. 31, 1955 | 15,770.88 | 40,770.88 |
*1366 At Bradley's request no payment was made for the year ending March 31, 1948. There had been a fire at the mine and petitioner excused payment in order that production might be resumed. 2
*86 Upon receipt of the final payment on March 31, 1955, all of the instruments held by the escrow holder were delivered to and recorded by Bradley. At the time Bradley acquired title from escrow a substantial quantity of hubernite ore remained en bloc in four of the Ima claims.
As a result of the conveyance of title to the Ima properties to Bradley, petitioner was divested of all its fixed assets and has not since conducted any business for profit.
Petitioner's adjusted basis in all the Ima properties as of November 30, 1951, was $ 82,999.95.
Petitioner reported the proceeds received under the provisions of the option agreement of April 1, 1946, as capital gains. Respondent determined that these proceeds were ordinary income and determined the deficiencies here in issue.
Petitioner retained no economic interest in the Ima properties. The amounts received by petitioner from Bradley during the taxable years were payments received in exchange for the sale of a capital asset held for a period in excess of 6 months.
OPINION.
The question presented is whether all or any part of the moneys received by petitioner pursuant to an agreement entered into on April 1, 1946, were proceeds from the*87 sale of a capital asset or were ordinary income received under a lease agreement.
On April 1, 1946, petitioner entered into an option agreement with the Bradley Mining Company granting Bradley sole option to purchase the Ima Mine properties from the petitioner for the total purchase price of $ 500,000. The pertinent details of the agreement appear in the Findings of Fact.
Petitioner contends that the agreement constituted a sale of its interest in the Ima Mine properties and that it is entitled to capital gains treatment of all the proceeds received. In the alternative, petitioner contends that some portion of the proceeds received is entitled to capital gains treatment.
Respondent argues that the option agreement entered into between petitioner and Bradley was, in reality, a lease and that the sums received pursuant thereto constituted ordinary income to the petitioner.
*1367 The proper characterization of contracts for the disposal of mineral rights has long been a fruitful area for tax litigation.
In determining whether a particular transaction is a sale or lease we may look to the language employed by the parties, the subject matter, and the surrounding circumstances. *88 Wesley W. West, 3 T.C. 431">3 T.C. 431, 448 (1944), affd. 150 F. 2d 723 (C.A. 5, 1945).
The key to the problem is whether the party disposing of the property right retained an economic interest in the property. Palmer v. Bender, 287 U.S. 551 (1933); Commissioner v. Southwest Expl. Co., 350 U.S. 308">350 U.S. 308 (1956).
After careful study of the agreement of April 1, 1946, and of the attendant circumstances, we are convinced and have found that petitioner retained no economic interest in the Ima Mine properties and that the agreement was a contract of sale.
The agreement itself is couched in terms descriptive of a sale. It gave Bradley sole option to purchase petitioner's interests in the Ima Mine properties for the total purchase price of $ 500,000. Because of prior payments, the balance due at the time of the execution of the agreement was $ 380,000. This balance was to be discharged by annual payments of $ 25,000 each, to be made until the debt was satisfied. These payments were fixed and were wholly unrelated to production.
In the event that the net returns from metals, minerals, *89 and ores extracted by Bradley from the Ima Mine and the Mazda group of mining claims (adjoining Ima and for the working of which Bradley used Ima's tunnels) exceeded $ 400,000 in any one year, Bradley was to pay petitioner 5 per centum of the excess. These payments were termed royalties and were to be made in addition to the regular $ 25,000 payment and were to be applied on the $ 500,000 purchase price.
Bradley, in fact, made annual payments of $ 25,000 to petitioner during each of the years ended March 31, 1947, through March 31, 1955, with the exception of 1948 when petitioner excused payment because of a fire at the mine. In addition, Bradley made payments equaling 5 per centum of production in excess of $ 400,000 during each of the years ended March 31, 1951, through March 31, 1955. These payments, based on production, in no way altered the total purchase price. Their only effect was to hasten the time when the $ 500,000 obligation was satisfied. It was, in truth, unnecessary that petitioner look to production for the return of any part of its capital investment.
Upon receipt of the final payment on March 31, 1955, the instruments conveying title to the properties were delivered*90 from escrow to Bradley. The conveyance of title divested petitioner of all its fixed assets and it has not since conducted any business for profit.
*1368 Bradley did not acquire a worked-out mine. At the time it obtained the instruments of title from the escrow holder a substantial quantity of hubernite ores remained en bloc in four of the Ima claims.
We have held that the transaction here in issue constituted a sale of petitioner's property rights in the Ima Mine, that petitioner retained no economic interest in the properties, and that petitioner was entitled to capital gains treatment on all the proceeds of the transaction. 3 This conclusion finds ample support in many decided cases. Helvering v. Elbe Oil Land Co., 303 U.S. 372">303 U.S. 372 (1938); Barker v. Commissioner, 250 F. 2d 195 (C.A. 2, 1957); Crowell Land & Min. Corp. v. Commissioner, 242 F. 2d 864 (C.A. 5, 1957), reversing 25 T.C. 223">25 T.C. 223; Maude W. Olinger, 27 T.C. 93">27 T.C. 93 (1956); Charles H. Remer, 28 T.C. 85 (1957), affd. 260 F. 2d 337*91 (C.A. 8, 1958).
Respondent relies heavily on this Court's opinion in Lincoln D. Godshall, 13 T.C. 681">13 T.C. 681 (1949). That case is similar to the case at bar in that there, as here, title deeds to mining properties were placed in escrow to be delivered to a mining company upon final satisfaction of a fixed sum. There is, however, a crucial difference. In Godshall the annual payments were payable solely out of the proceeds of mined ores. Here, the annual payments of $ 25,000 were due, regardless of production.
Respondent asserts that the agreement between petitioner and Bradley cannot be regarded as a contract of sale since it was devoid of a forfeiture provision. Bradley could abandon the agreement by giving petitioner 30 days' notice, making certain payments, and surrendering possession of the property. This same factor was present in Helvering v. Elbe Oil Land Co., supra,*92 and Barker v. Commissioner, supra.It was not regarded as controlling in those cases and we do not so regard it here. Moreover, it should be noted that Bradley could not abandon the agreement so long as it owned, possessed, or controlled the Mazda group of mining claims.
Our holding on petitioner's primary contention makes it unnecessary for us to consider his alternate theories.
Decision will be entered for the petitioner.
Footnotes
1. It is stipulated that the date of the first supplemental agreement was December 22, 1944; however, the instrument bears the date December 19, 1944.↩
2. A supplemental agreement modifying the agreement of April 1, 1946, was entered into by petitioner and Bradley on April 22, 1947. This supplemental agreement provided for modifications in the payments due on the purchase price during each of the years ended April 1, 1947, 1948, and 1949.↩
3. See section 117(a) of the Internal Revenue Code of 1939 and section 1221 of the Internal Revenue Code of 1954↩.