*4123 1. The bonus in addition to reserved royalties received by the petitioner in payment for a certain oil lease was not a return of capital. Appeal of Nelson Land & Oil Co.,3 B.T.A. 315.
2. The bonus received as set forth above is income and is not taxable under the provisions of section 206 of the Revenue Act of 1921. Henry L. Berg v. Commissioner,6 B.T.A. 1287.
3. The evidence does not sustain discovery value of the lease here involved in addition to such value already determined by the respondent.
*332 The respondent has asserted a deficiency in income tax for the year 1922, in the amount of $46,539.42. The petitioner contends:
(1) That the respondent erroneously included the amount of $250,000 received as bonus for certain oil leases in his income for the taxable year and avers that such amount was not income, but a return of capital;
(2) That the amount in question was derived from a so-called bonus received upon the granting of leases to certain oil companies on property that had been in his possession*4124 for more than 25 years, and that even if such amount was income it is subject to a maximum tax of only 12 1/2 per cent under the provisions of section 206 of the Revenue Act of 1921; and
(3) That the respondent has failed to allow any depletion with respect to the lease bonus of $250,000 in conformity with the provisions of article 215 of Regulations 62 as amended by Treasury Decision 3938.
The parties have stipulated the facts, and from such stipulation, which we accept, we make the findings which follow:
FINDINGS OF FACT.
R. H. Hazlett is an individual residing in El Dorado, Butler County, Kans. Between the years 1885 and 1895 he purchased certain real estate in Butler County, Kansas, paying therefor the sum of $11,850. The description of the various tracts purchased and the price paid therefor are as follows:
| Tract | Acres | Price paid |
| SE. 1/4 sec. 36, T. 23, R. 4 | 150 | $2,800 |
| W. 1/2 sec. 6, T. 24, R. 5 | 320 | 4,000 |
| E. 1/2 sec. 6, T. 24, R. 5 | 280 | 1,850 |
| E. 1/2 sec. 1, T. 24, R. 4 | 320 | 3,200 |
| Total | 1,080 | 11,850 |
On the 13th day of June, 1922, he granted to the Phillips Petroleum Co. of Bartlesville, Okla., a lease including 680 acres of the above*4125 described land, of which the following is a copy:
*333 AGREEMENT, Made and entered into the 13th day of June, 1922, by and between R. H. Hazlett and Isabella Nazlett, his wife, of , party of the first part, hereinafter called lessor (whether one or more) and Phillips Petroleum Company, party of the second part, lessee.
WITNESSETH, That the said lessor, for and in consideration of One ($1.00) Dollars cash in hand paid, receipt of which is hereby acknowledged and of the covenants and agreements hereinafter contained on the part of lessee to be paid, kept and performed, has granted, demised, leased and let and by these presents does grant, demise, lease and let unto the said lessee, for the sole and only purpose of mining and operating for oil and gas, and laying pipe lines, and building tanks, powers, stations and structures thereon to produce, save and take care of said products, all that certain tract of land situate in the County of Butler, State of Kansas, described as follows, to-wit:
The North Half (except the North Half of the Northwest Quarter); the South Half of the South Half, and the Northwest Quarter of the Southeast Quarter of Section Six (6), Township*4126 Twenty-four (24) South, Range Five (5) East, and the East Half of the East Half and the West Half of the Northeast Quarter of Section One (1), Township Twenty-four (24) South, Range Four (4) East, and containing 680 acres, more or less.
It is agreed that this lease shall remain in force for a term of One (1) years from this date, and as long thereafter as oil or gas, or either of them is produced from said land by the lessee.
In consideration of the premises the said lessee covenants and agrees:
1st. To deliver to the credit of the lessor, free of cost, in the pipe line to which he may connect his wells, the equal one-eighth part of all oil produced and saved from the leased premises.
2nd. To pay the lessor one-eighth of the proceeds of the gas from each well where gas only is found, while the same is being used off the premises, and if used in the manufacture of gasoline or any other product, a royalty of one-eighth (1/8) payable monthly at the prevailing market price, and lessor, to have gas free of cost from any well for all stoves and all inside lights in the principal dwelling house on said land during the same time by making his own connections with the wells at*4127 his own risk and expense.
3rd. To pay lessor for gas produced from any oil well and used off the premises one-eighth of the proceeds thereof monthly, and if used in the manufacture of gasoline or any other product, a royalty of one-eighth (1/8) payable monthly at the prevailing market price.
If said lessor owns a less interest in the above described land than the entire and undivided fee simple estate therein, then the royalties and rentals herein provided shall be paid the lessor only in proportion which his interest bears to the whole and undivided fee.
Lessee shall have the right to use, free of cost, gas, oil, and water produced on said land for its operation thereon, except water from wells of lessor.
When requested by lessor, lessee shall bury its pipe lines below plow depth.
No well shall be drilled nearer than 20 feet to the house or barn now on said premises, without the written consent of the lessor.
Lessee shall pay for damages caused by its operations to growing crops on said land.
Lessee shall have the right at any time to remove all machinery and fixtures placed on said premises, including the right to draw and remove casing.
If the estate of*4128 either party hereto is assigned, and the privilege of assigning in whole or in part is expressly allowed - the covenants hereof shall extend to their heirs, executors, administrators, successors or assigns, but no change in *334 the ownership of the land or assignment of rentals or royalties shall be binding on the lessee until after the lessee has been furnished with a written transfer or assignment or a true copy thereof; and it is hereby agreed in the event this lease shall be assigned as to a part or as to parts of the above described lands and the assignee or assignees of such part or parts shall fail or make default in the payment of the proportionate part of the rents due from him or them, such default shall not operate to defeat or affect this lease in so far as it covers a part or parts of said lands upon which the said lessee or any assignee thereof shall make due payment of said rental.
Lessor hereby warrants and agrees to defend the title to the lands herein described, and agrees that the lessee shall have the right at any time to redeem for lessor, by payment, any mortgages, taxes or other liens on the above described lands, in the event of default of payment*4129 by lessor, and be subrogated to the rights of the holder thereof.
It is agreed that lessee shall commence the drilling of a well on said land on or before September 1, 1922, and prosecute the same with reasonable diligence to a depth of 2600 feet, unless oil or gas in paying quantities is discovered at a lesser depth, said well to be at the southeast corner location of the Southeast Quarter of Section 1-24-4. If drilling is not commenced on or before September 1, 1922, this lease shall terminate as to both parties.
In Testimony Whereof We Sign, this the day of June, 1922.
In accordance with the provisions of this lease the Phillips Petroleum Co. commenced a well on July 31, 1922, and finished it August 24, 1922, at a depth of 2,475 feet, at which point oil was produced in paying quantities. This well is located near the southeastern corner and 200 feet west of the east line and 200 feet north of the south line of the east half of the southeast quarter of section 1, township 24 south, range 4 east.
On September 6, 1922, after the completion of the well described above, certain instruments were executed by and between Hazlett as lessor and the Gypsy Oil Co. as lessee, whereby*4130 the lessor does "grant, demise, lease and let unto the lessee" for the terms specified therein and for the "sole and only purpose of mining and operating for oil and gas, etc." from the remaining 400 acres of the 1,080-acre tract first described, for a consideration of $250,000, and in addition thereto the usual one-eighth royalty to the lessor. The tracts affected by these contracts and the portion of the $250,000 allocated to each are as follow:
| Tract | Acres | Portion of consideration allocated |
| W. 1/2 SE. 1/4 sec. 1, T. 24, R. 4 | 80 | $80,000 |
| N. 1/2 NW. 1/4 sec. 6, T. 24, R. 5 | 80 | 50,000 |
| SE. 1/4 sec. 36, T. 23, R. 4 | 160 | 40,000 |
| N. 1/2 SW. 1/4 sec. 6, T. 24, R. 5 | 80 | 80,000 |
| 400 | 250,000 |
All the instruments are identical with the exception of the legal description of the property. The following is a copy of one of these leases for all the purposes of this proceeding:
*335 OIL AND GAS MINING LEASE
AGREEMENT, Made this 6th day of September, 1922, by and between Robert H. Hazlett and Isabella Hazlett, his wife, of El Dorado, Kansas, and Gypsy Oil Company, a corporation, hereinafter respectively called lessor*4131 and lessee, whether one or more.
That the lessor, for and in consideration of the sum of One DOLLARS, paid by lessee, the receipt of which is hereby acknowledged, and of the covenants and agreements hereinafter contained on the part of the lessee to be kept and performed, has granted, demised, leased and let, and by these presents does grant, demise, lease and let unto the lessee, for the sole and only purpose of mining and operating for oil and gas, installing gas pumps, laying pipe lines, building tanks, stations and structures thereon to produce, store and convey said products, all that certain tract of land situated in the county of Butler, State of Kansas, described as follows, to-wit:
West half of the Southeast quarter (W/2 of SE/4) of Section 1, Township 24 S., Range 4 E. containing 80 acres, more or less.
TO HAVE AND TO HOLD the same for the term of five years from this date and as long thereafter as oil or gas or either of them is produced from said land by lessee, its successors, or assigns.
In consideration of the premises, the lessee covenants and agrees:
FIRST: To pay the lessor as royalty one-eighth part of the proceeds of all the oil saved and sold from*4132 that produced on said premises and to run such oil to pipe line companies to which lessee may connect its well or wells under division orders placing one-eighth part of said proceeds to lessor's credit, or at lessee's option, to pay to lessor one-eighth part of the market value of such oil in the field where produced on the day the same is sold, run or stored, and in this last event, settlement shall be made by lessee by the 15th day of each month for the royalty accrued during the preceding month;
SECOND: To pay lessor as royalty for all gas sold, including casing-head gas, a sum equal to one-eighth of the proceeds of such sale, and, in case the lessee shall use or utilize such gas otherwise than in operating the premises, to pay lessor as royalty a sum equal to one-eighth of the value of such gas, such value to be computed and determined on the basis indicated by the schedule marked Figure 1 of the Regulations of the Department of the Interior governing the utilization of casing-head gas from restricted Indian lands other than the Osage Nation, approved August 10th, 1917; settlement to be made every three months for the gas sold or utilized during the preceding three months. And*4133 the lessor shall have gas free of cost from any well producing gas only for all stoves and inside lights in the principal dwelling house on said land by making his own connection with such well.
The lessee agrees to commence drilling a well on said premises within one year from date hereof, or pay at the rate of $80.00 Dollars for each additional year such commencement is delayed from the time above mentioned. The completion of such well shall be and operate as a full liquidation of all rentals under this provision during the remainder of the term of this lease, unless the same shall prove to be a dry hole, in which event, at the next succeeding rental paying date, the lessee may resume payment of rentals, such payments to cease on the completion of a producing well.
The lessee shall have the right to use, free from royalty or rental, oil and gas produced from said land in drilling and operating thereon, and also water from wells other than those of the lessor.
When requested by lessor, the lessee shall bury pipe lines below plow depth. The lessee shall pay for damages caused by drilling to growing crops.
*336 If the lessor owns a less interest than the entire*4134 undivided fee simple in above land, then the royalty and rentals hereinbefore provided shall be paid to the lessor only in the proportion which his interest bears to the entire fee.
On the termination of this lease for any cause the lessee shall have the right at all times to remove all machinery, fixtures and property placed on said premises, including the right to draw and remove casing, and all machinery, fixtures, property, and casing on said premises shall remain the property of the lessee.
The lessee is given the right to assign this lease in whole or in part and if it be assigned as to a particular portion of the acreage covered thereby lessee shall be liable for royalties accruing only from production on the acreage retained and he liable for rentals only in the proportion that the acreage unassigned bears to the entire leased acreage, and lessee's assignee shall be liable for royalties accruing only from production on the acreage assigned and be liable for rentals only in the proportion the acreage assigned bears to the entire leased acreage, and in no event shall this lease be cancelled or forfeited as to lessee for failure to pay rentals or royalties so long as lessee*4135 shall pay rentals or royalties on the acreage retained, nor as to such assigns so long as they shall pay rentals or royalties on acreage assigned.
This lease shall be forfeited or cancelled only for failure to make payments for delay in drilling, and the right to forfeit or cancel, or to have it declared forfeited, cancelled or set aside for failure to comply in whole or in part with any implied condition, covenant, stipulation, agreement, undertaking, duty or obligation, is hereby expressly waived and released.
If the leased premises are hereafter owned in severalty or in separate tracts the premises nevertheless shall be developed and operated as an entirety and royalties shall be paid to each separate owner in the proportion that the acreage owned by him bears to the entire leased acreage, and lessee shall not be bound by any change in the ownership of the leased acreage unless and until notified thereof in writing, and when such change is effected by will, deed or other written instrument said notice shall be accompanied by such instrument or a duly authenticated copy thereof. This stipulation and all other stipulations, covenants, conditions, agreements and terms of this*4136 instrument shall extend to and be binding upon the heirs, executors, successors, assigns and the legal representatives of the parties hereto.
If the lessee shall commence to drill a well within the term of this lease or any extension thereof the lessee shall have the right to drill such well to completion with reasonable diligence and dispatch, and if oil or gas, or either of them be found in paying quantities this lease shall continue and be in force with like effect as if such well had been completed within the term of years herein first mentioned.
All payments under this lease shall be made to the lessor, or, with like effect, check for such payment may be mailed to Eldorado National Bank of Eldorado, Kansas or its successors, for deposit to lessor's credit.
The lessee, its successors or assigns, shall have the right at any time, on payment of One Dollar to the lessor, his heirs or assigns, to surrender this lease for cancellation, after which all payments and liabilities thereafter to accrue under and by virtue of its terms shall cease and determine, provided that this surrender clause and the option therein reserved to the lessee shall cease and become absolutely inoperative*4137 immediately and concurrently with the institution of a suit in any court of law or equity by the lessee to enforce this lease or any of its terms or to recover possession of the leased acreage, or *337 any part thereof against or from the lessor, his heirs, executors, administrators, successors or assigns, or any person or persons.
It is understood that the above described land constitutes no part of the lessor's homestead.
IN WITNESS WHEREOF, the parties have hereunto set their hands this the day and year first above written.
On September 6, 1922, the well described above, located near the southeast corner of the southeast quarter of section 1, township 24, range 4, was the only producing well on the taxpayer's property. Approximately 12 acres of the taxpayer's property, covered by the above contracts with the Gypsy Oil Co., lay within the area of 160 square acres about the producing well.
The Commissioner has allowed a discovery value attaching to a portion of the property included in the previously mentioned lease of September 6, 1922, because of the completion on August 24, 1922, of the previously mentioned discovery well.
Hazlett did not include as taxable*4138 income in his tax return for the year 1922, any part of the $250,000 consideration received from the Gypsy Oil Co. as described above. The Commissioner has included the entire sum of $250,000 as taxable income to Hazlett for the year 1922 in the deficiency letter attached to and made a part of Hazlett's appeal to the United States Board of Tax Appeals, and has not allowed any deduction from this amount representing depletion, and has assessed a tax without regard to the provisions of section 206 of the Revenue Act of 1921, providing a maximum tax of 12 1/2 per cent on capital net gain.
OPINION.
LANSDON: The petitioner's contention that the amount of $250,000 received as set forth in our findings of fact was a return of capital requires no discussion. We have already decided that in such circumstances amounts so received are advance payments of rental or royalty. The principles upon which we based this conclusion are fully stated and the supporting law is copiously cited in our prior decision. Appeal of Nelson Land & Oil Co.,3 B.T.A. 315. The second contention of the petitioner must likewise be decided adversely to him on the authority of *4139 Henry L. Berg v. Commissioner,6 B.T.A. 1287.
To support his claim for depletion of the bonus received in connection with the Gypsy leases, the petitioner relies on the following provision of section 214 of the Revenue Act of 1921:
SEC. 214. (a) That in computing net income there shall be allowed as deductions: * * *
*338 (10) * * * Provided further, That in the case of mines, oil and gas wells, discovered by the taxpayer, on or after March 1, 1913, and not acquired as the result of purchase of a proven tract or lease, where the fair market value of the property is materially disproportionate to the cost, the depletion allowance shall be based upon the fair market value of the property at the date of the discovery, or within thirty days thereafter: * * *. In the case of leases the deductions allowed by this paragraph shall be equitably apportioned between the lessor and lessee.
For administrative purposes, the statute cited above is interpreted in article 215 of Regulations 62 as follows:
Depletion - Adjustments of accounts based on bonus or advanced royalty. - (a) Where a lessor receives a bonus or other sum in addition to royalties, *4140 there shall be allowed as a depletion deduction in respect of the bonus an amount equal to that proportion of the cost or value of the property on the basic date which the amount of the bonus bears to the sum of the bonus and the royalties expected to be received. Such allowance shall be deducted from the amount remaining to be recovered by the lessor through depletion, and the remainder is recoverable through depletion deductions on the basis of royalties thereafter received.
If the petitioner is entitled to depletion under the law and regulations as set forth above, the amount thereof must be determined by the application of section 234 of the Revenue Act of 1921, which establishes three bases for the computation of depletion: The value of the natural resources at March 1, 1913; the cost of such property if acquired subsequent to that date; or the discovery value. In the instant proceeding, there is no value at March 1, 1913, other than that of the land for agricultural purposes, which is not a factor in this controversy. There is no cost which may be ascribed to the natural resources in question.
Judgment will be entered for the respondent.