(dissenting).
I dissent. Appellant (referring to it and its predecessor as such) was named trustee of the residuary estate of one Kleinmeyer in his will, and received distribution of the residuary estate on November 15, 1916, in which was included certain lands, hereinafter referred to as the leased land. The fair market value of t’he leased land was $50,997.69 on that date, but the “property was an unproven tract of land and had no known oil value at said date.”
The leased land was located in the so-called “Torrance” oil field, discovery of oil in which was by a well drilled and brought in during the year 1921. On June 30, 1924 the leased land “was proven oil bearing property as a result of its known geological condition at that time and production from oil wells on property owned by other persons immediately adjoining it.”
On the date last mentioned, appellee leased the “leased land” to a lessee for a term of “twenty years from the date thereof and so long thereafter as petroleum and natural gas shall be produced therefrom in paying quantities.” The lessee agreed to “commence operations preparatory to the drilling of at least twelve wells” upon the land within 15 days, and to “commence actual drilling of each” of the wells within 60 days from the date of the lease, and to drill other wells until a total of 85 were completed. The lessee agreed to pay cash royalties on petroleum produced, and a cash bonus of $150,000.
The bonus was paid on July 1, 1924. The lessee- performed its covenants in the lease with respect to the drilling of the wells. The first well on the leased land which had a commercially productive basis was brought in on September 17, 1924. On December 31, 1924, there were orf the leased land 18 completed wells, and others were being drilled.
Appellant as trustee filed an income tax return for the trust estate for the year 1924, but did not include as income the bonus payment in the sum of $150,000. The Commissioner of Internal Revenue audited such return and determined a deficiency in appellant’s tax for that year, by adjusting the gross income to include the amount of the bonus, but “refused to allow as a deduction from gross income any amount as depletion on said bonus.” Thereafter appellant paid the tax to appellee, and filed a claim for refund which was denied on June 19, 1931, by the Commissioner.
On June 17, 1933, appellant filed an action to recover the sum of $15,330.65 of the tax theretofore paid, on the ground that it was entitled to a deduction from gross income “for depletion upon said bonus.” Upon the facts, which were stipulated, the trial court concluded as a matter of law that appellant was “entitled to no allowance or deduction for depletion of said bonus.” Judgment was entered in favor of appellee, accordingly, and this appeal was taken therefrom.
Inasmuch as a bonus payment “is not proceeds from the sale of property, but payment in advance for oil and gas to be extracted,” it is therefore gross income. Herring v. Commissioner, 293 U.S. 322, 324, 55 S.Ct. 179, 79 L.Ed. 389. The Revenue Act of 1924, § 214, 43 Stat. 269, 270, provides:
“(a) In computing net income there shall be allowed as deductions: * * *
“(9) In the case of mines, oil and gas wells, other natural deposits, and timber, a reasonable allowance for depletion and for depreciation of improvements, according to the peculiar conditions in each case; such reasonable allowance in all cases to be made under rules and regulations to be prescribed by the Commissioner, with the approval of the Secretary. In the case of leases the deduction allowed by this paragraph shall be equitably apportioned between the lessor and lessee.”
A taxpayer being the recipient of a bonus is therefore allowed a depletion deduction. Burnet v. Harmel, 287 U.S. 103, 111, 53 S.Ct. 74, 77 L.Ed. 199; Murphy Oil Co. v. Burnet, 287 U.S. 299, 53 S.Ct. 161, 77 L.Ed. 318; Palmer v. Bender, 287 U.S. 551, 53 S.Ct. 225, 77 L.Ed. 489. Such depletion *361deduction allowable in respect of the bonus is “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.” Article 215, Regulations 45, as amended November 13, 1926, by Treasury Decision 3938, V-2, C.B. 117, which was held reasonable within a statute similar to the one in question, in Murphy Oil Co. v. Burnet, supra.
Under this provision the mechanics of computing depletion deduction for the bonus is as follows: The amount of the bonus is divided by the total amount expected to be received from both bonus and royalties, thus giving as the quotient what the percentage of the total the bonus is; the “cost or value of the property on the basic date” is multiplied by the percentage thus . obtained, and the product is the amount deductible from the bonus payment as depletion, in computing net income.
It is necessary in accordance with that computation to determine the “cost or value of the property on the basic date.” Under section 204 (c) this “cost or value,” in computing depletion deductions, is specified to be the same as provided in preceding subdivision (a) or (b), but section 204 (c), 43 Stat. 258-260, provides an exception hereinafter mentioned. Subdivision (a) (4) provides that “If the property was acquired by gift or transfer in trust on or before December 31, 1920, the basis shall be the fair market value of such property at the time of such acquisition.” Appellant obtained the leased land by a transfer in trust on November 15, 1916, at which time the fair market value of the property was $50,997.69, which figure represents no oil value whatever. In subdivision (c) the exception mentioned is “that in the case of mines, oil and gas wells, discovered by the taxpayer after February 28, 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 basis for depletion shall be the fair market value of the property at the date of discovery or within thirty days thereafter.”
The controversy here centers around the meaning of the words “property” and “discovery” as used in the following clause in section 204 (c) : “the basis for depletion shall be the fair market value of the property at the date of discovery or within thirty days thereafter.” (Italics supplied.)
With respect to the word discovery it is provided in article 222 (1) of Regulations 45: “For the purpose of section 204 (c) of the Revenue Act of 1924, an oil or gas well may be said to be discovered when there is either a natural exposure of oil or gas, or a drilling that discloses the actual and physical presence of oil or gas in quantities sufficient to justify commercial exploitation.”
With respect to the word “property” the same article provides: “(3) The ‘property’ which may be valued after discovery is the ‘well.’ For the purposes of these sections the ‘well’ is the drill hole, the surface necessary for the drilling and operation of the well, the oil or gas content of the particular sand, zone, or reservoir (limestone, breccia, crevice, etc.) in which the discovery was made by the drilling, and from which the production is drawn,'•to the limit of the taxpayer’s private bounding lines, but not beyond the limits of the proven area as heretofore provided.”
Appellee contends that, since there was no “discovery” as thus defined until September 17, 1924 (the date the first well was brought in), there was no “property” as thus defined (an oil or gas' well) when the bonus was paid on the prior July 1st; that therefore the exception in section 204 (c) has no application to the bonus payment; that, since section 204 (c) has no application, the basic date would be the one then existing, which would be the date the transfer in trust was made; that on that date the “cost or value.of the property” was nil, which, multiplied by the percentage obtained pursuant to the statute, would give a product of nothing, which would be the deduction for depletion permitted.
The statute (section 204 (c) may be taken to mean either (1) that it is mines or oil and gas wells which are discovered; or (2) that it is minerals, or oil and gas which are discovered. Appellee has taken the first. The meaning of the word “discovery” itself goes far in determining what the statute means. It implies the bringing to light of something previously unknown. Article 222 (1) of the regulations says that there -is discovery of an oil or gas well when there is either a natural exposure of oil or gas, or- a disclosure of “the actual and physical presence of oil or gas” by drilling. Thus it is shown by the regulation that it is the mineral which is discovered, and not the hole in the ground, *362through which the oil is extracted. When is discovery of the mineral made? The regulation says, when there is a natural exposure of the oil and gas, or by “a drilling that discloses the actual and physical presence” of it. Nothing in that regulation provides that a well must be drilled on the particular property leased. Drilling on adjacent lands might disclose oil. An existing well on the leased lands here in question is not a condition to the depletion. Herring v. Commissioner, supra, 293 U.S. 322, at page 325, 55 S.Ct. 179, 79 L.Ed. 389.
It is illogical and unreasonable to hold that there is no discovery of oil on lands until the presence of such oil becomes known by the drilling of a well on such lands. Suppose a small lot is surrounded by wells all near the boundary of the small lot; that the geological formation of the small lot is the same as that of the land surrounding it; and that all experts agree that there is oil on the small lot. It is absurd to say that there has been no discovery of oil on the small lot.
I therefore believe that “the date of discovery” as used in section 204 (c) means the date when the presence of oil became known, either by natural exposure, or by such drilling.on or near the lands in question, as discloses the actual and physical presence of oil or gas on the lands in question.
In the instant case, it was stipulated that the leased land “was proven oil bearing property”, on the date the lease was made. Therefore the date of discovery was on or prior to that date.
Finally, article 222 (3) of the regulations defines “property,” as used in section 204 (c) of the act, to be the “well.” It also defines the “well” to be the drill hole, a portion of the surface of the land, and the oil and gas content within certain limits. If this regulation means that there is “property” as used in the statute, only when there is a drilled well, then it is obvious that appellant had no property. I do not believe such a meaning can be given to the regulation, but, if it does condition ownership of such property on the existence of a well, it is contrary to Herring v. Commissioner, supra. I believe such regulation means that “property” includes, as used in section 204 (c) of the act, all the things mentioned therein, or it may mean the oil and gas content alone.
I conclude that appellant is entitled to a depletion deduction.