*49 Decision will be entered for the respondent.
The taxpayer, owner of mining rights, contracted to "let and grant possession" of them to a corporation under a "lease with option to purchase." By this instrument the taxpayer acknowledged a down payment of $ 11,000 and agreed to place in escrow a deed to the rights for delivery to the corporation after receipt of $ 139,000 "rental." The corporation agreed to pay specified percentages of net returns from all ore removed or sold in satisfaction of the "rental," but by written notice could at any time terminate the agreement and surrender the property, whereupon all amounts paid or payable for ore already removed would be retained by the taxpayer "as full payment of all royalty and/or rental" under the terms of the "lease."
(1) On the evidence, held, that the taxpayer reserved an economic interest in the mining rights. Burton-Sutton Oil Co. v. Commissioner, 328 U.S. 25">328 U.S. 25.
(2) The amounts received by the taxpayer in 1942 and 1943 as payments under the contract, held, taxable as royalties and not as sale proceeds.
*681 The Commissioner determined a deficiency of $ 7,086.50 in petitioner's income and victory tax for 1943 in part by treating payments received in 1942 and 1943 from the assignee of mining claims under a lease with option to purchase as royalties and, hence, ordinary income. Petitioner contends that such payments were derived from the sale of the claims and are taxable as capital gains. The proceeding was submitted upon a stipulation, which we incorporate by reference as findings of fact, and from which it appears that:
FINDINGS OF FACT.
Petitioner, a retired mining engineer, residing at Los Angeles, California, filed his income tax returns for 1942 and 1943 with the collector of internal revenue for the sixth district*51 of California.
In 1933 he acquired an undivided 50 per cent interest in 18 mining claims in the Resting Springs Mining District near Tecopa, California. *682 His son, Dr. Leon D. Godshall, and his associate, Mrs. Marvel Belden, acquired the other 50 per cent interest. In January 1940 petitioner acquired an undivided 50 per cent interest in an adjoining claim, and his son and associate likewise acquired the other 50 per cent interest. Prior to 1942 petitioner had recovered the basis of his interest in the 18 claims; he paid $ 1,250 for his interest in the nineteenth. These 19 properties, which will be referred to as the Tecopa claims, contained lead, gold, and silver ores.
On January 23, 1940, the three owners and Shoshone Mines, Inc., (hereinafter called Shoshone) entered into an agreement which they styled a "Lease with Option to Purchase." In it they recited that Shoshone had paid $ 11,000 to the Security-First National Bank of Los Angeles in escrow for the credit of the owners and that the owners had deposited in escrow with the same bank "a copy of this lease" and title deeds to the 19 claims and all buildings, machinery, equipment, etc., on them, said deeds to be delivered*52 by the bank to Shoshone upon performance of all conditions thereinafter described. The owners then agreed to "let and grant possession" of the mining properties covered by the 19 claims to Shoshone "for and in consideration of the rents, royalties, covenants and agreements hereinafter reserved."
2. The lease term commences at the date hereof, expiring on the 26th day of January, 1949, unless sooner forfeited, surrendered or terminated under the terms hereof.
Shoshone was given the exclusive right "on and after the commencement of the term of this lease" to occupy, mine, and develop the property; to prospect for, ship, and market ores and to use all buildings, machinery, and equipment for such purposes. It was recited in the contract that "The rental for said property under this lease" was $ 139,000, of which $ 11,000 was acknowledged paid and the remainder was payable in annual installments ranging from $ 6,000 to $ 24,000 on January 26 of eight succeeding years. But these future installments, here termed "rental," were not an absolute liability. They were payable only out of the proceeds of mined ores and all liability for them was to cease if the agreement should be terminated*53 or forfeited. In satisfaction of this "rental," Shoshone agreed to pay the bank in escrow for the owners' credit "a royalty from the net mill, mint or smelter returns from all ore or products removed or sold from said premises." This royalty ranged from 10 per cent to 20 per cent on mill and direct smelted ores, according to the assay or return value per ton, and its crediting after payment in escrow to bank was expressly "to reduce the amount of the rental payments." Shoshone "may, at any time, terminate this agreement and abandon the property" by giving written notice, a quitclaim deed, or other instrument to clear title, and surrendering possession. In such event Shoshone *683 was required to pay only the rental or royalty due on ores already mined, and all amounts previously paid were to belong to the owners "as full payment of all royalty and/or rental for the use of said property under the terms of this lease."
Upon payment of "all rentals" the owners agreed that the deeds to "the property leased" be delivered from escrow to Shoshone. Shoshone agreed "during the term of this lease" to carry on operations carefully; to keep the property protected by insurance; to observe*54 all Government regulations; and, in case of cancellation, to return the property in as good condition as when received or to pay reasonable damages. The owners reserved the right of entry and inspection, were entitled to living quarters on the property for their agent until all payments should be made, and required Shoshone to keep conspicuously posted a notice that the developing and mining were being done at its expense and without responsibility by the owners. Shoshone was required to pay all taxes on the property after date of the agreement, and was authorized to sublease parts of it. Shoshone's failure to make a payment when due subjected it, at the owners' option, to a forfeiture of payments made, and if such default should not be cured within 30 days after receipt from the owners of a written notice, the agreement could be canceled and forfeited payments retained by the owners "as liquidated damages and/or as rentals and/or as consideration for the benefits of this agreement," and the bank was then required to return to the owners all documents deposited in escrow.
When this agreement was signed and on January 23, 1940, the parties to it filed with the Security-First National*55 Bank of Los Angeles an implementing escrow agreement, the owners deposited deeds to the Tecopa claims with the bank, and Shoshone deposited the initial $ 11,000. The terms of the agreement were fully carried out by the end of 1943. Shoshone made payments aggregating $ 22,714.48 in 1940, $ 38,735.46 in 1941, $ 55,894.37 in 1942, and $ 21,655.69 in 1943, a total of $ 139,000, of which petitioner received 50 per cent, or $ 69,500. On December 30, 1943, Shoshone received the deeds from the bank. Except the initial payment of $ 11,000 and the final payment of $ 1,862.85, all other payments were "royalties" paid from the net mill, mint, or smelter proceeds received by Shoshone from operation of the property.
Petitioner reported his whole share of Shoshone's payments in 1940 and 1941 as income, but later filed claims for refund of tax, asserting the right to report his receipts as capital gain on an installment sale of his interest in the Tecopa claims. The Commissioner determined a capital gain for 1940 in respect of petitioner's share of the initial $ 11,000 payment, but held his share of other payments to be ordinary income, subject to a depletion allowance. For 1942 and 1943 the*56 Commissioner included in petitioner's ordinary income his *684 shares of the payments received in those years, with deductions for depletion and some minor expenses.
OPINION.
Although the instrument defining the parties' rights in the mining claims is styled a lease and the transferee's payments are called rentals or royalties, petitioner argues that in fact he made a sale of his interests and that the transaction should be classed for tax purposes according to the meaning and intent of the instrument as a whole. While the scope of this argument would cover the issue in the case of normal transactions, it falls short here because a conveyance or assignment of minerals and mineral rights for Federal tax purposes differs from similar transactions involving other kinds of property. Even in the case of a technical sale, consummated by passage of title, the seller is deemed to have "maintained a capital investment or economic interest" in the mineral property transferred if all or part of the price is payable out of the minerals produced or the net proceeds of production. Burton-Sutton Oil Co. v. Commissioner, 328 U.S. 25">328 U.S. 25. So holding in respect*57 of oil-bearing properties, the Supreme Court expressly rejected the argument:
* * * that ownership of a royalty or other economic interest in addition to the right to net profits is essential to make the possessor of a right to a share of the net profit the owner of an economic interest in the oil in place. * * *
It reasoned, on the contrary, that:
* * * the form of the instrument of transfer and its effect on the title to the oil under local law are not decisive * * *, there must be a determination under federal tax law as to "whether the transferor has made an absolute sale or had retained" such economic interest * * *. Kirby Petroleum Co. v. Commissioner, supra [326 U.S. 595]. * * * we have construed an assignment of oil leases for cash and a deferred payment, "payable out of oil only, if, as, and when produced", as the reservation of an economic interest in the oil -- not a sale. Thomas v. Perkins, 301 U.S. 655">301 U.S. 655.
The same rules are applicable to ore-bearing properties. Burnet v. Harmel, 287 U.S. 103">287 U.S. 103. In determining tax incidence the essential test is thus whether or not petitioner held an economic*58 interest in the minerals in place. If he did, the amounts paid him out of the proceeds of their production constitute ordinary taxable income, and he is entitled to a deduction for depletion.
In our opinion petitioner and his associates clearly reserved an economic interest in the ore by their instrument of transfer. They recited a consideration of $ 139,000 as total "rental" payable, but, apart from the initial deposit of $ 11,000, none of this "rental" was a fixed liability. By subsequent provisions of the contract it was to be satisfied, if at all, by specified "royalties" on the ores actually mined, and *685 if ore production should prove to be small or unprofitable, Shoshone was free to terminate the contract without further obligation than the payment of "rental" or "royalties" on such tons as it had extracted at that time. Petitioner obviously retained rights to payments from ore or its proceeds, and his future installments of the recited "rental" were wholly contingent on what Shoshone could or would produce. Unlike the assignor in Helvering v. Elbe Oil Land Development Co., 303 U.S. 372">303 U.S. 372, he did not at the date of the contract convey*59 all right, title, and interest in the properties to Shoshone. Furthermore, there the consideration of $ 2,000,000 was "to be paid without reference to and without being in any manner based upon the production of oil from the properties conveyed," whereas here all of the consideration except the initial sum of $ 11,000 under the contract was payable out of the ores produced from the properties involved.
Petitioner relies primarily on Rotorite Corporation v. Commissioner (C. C. A., 7th Cir.), 117 Fed. (2d) 245, wherein payments made as royalties for use of a patent were deemed part of the purchase price of the patent because applicable to it in case the licensee should exercise an option to buy. The court took the view that in the taxable year royalty payments were so large that exercise of the option was to be inferred. But the Rotorite case does not involve mineral properties on which the royalties come from sale of ore. It is this right to a part of the property itself which gives rise to the view of an economic interest retained by the assignor and which characterizes the payments as royalties, not sale proceeds. Title to the ore is not*60 decisive, Burton-Sutton Oil Co. v. Commissioner, supra, and it is hence immaterial when a sale was consummated in the ordinary sense, or when the option to purchase was exercised. See G. C. M. 23999, 1943 C. B. 144.
Decision will be entered for the respondent.
Murdock, J., dissenting: Here there was in fact a sale of a capital asset held for more than six months. The statute requires that when such a capital asset is sold the amount realized from the sale shall be offset by the adjusted basis and the excess shall be taxed as a long term capital gain. Secs. 111 (a), (b), 117 (a) (1), (4). Cf. Rotorite Corporation v. Commissioner, 117 Fed. (2d) 245, reversing 40 B. T. A. 1304; Goldfields of America, Ltd., 44 B. T.A. 200; Helser Machine & Marine Works, Inc., 39 B. T. A. 644; Judson Mills, 11 T. C. 25; Virginia Iron, Coal & Coke Co., 37 B. T. A. 195; affd., 99 Fed. (2d) 919; certiorari denied, 307 U.S. 630">307 U.S. 630.*61 The report fails to follow the statute, and for reasons which I deem inadequate.