25

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Opinion of the Court.

oil. Technical title to the property depleted would ordinarily be required for the application of depletion or depreciation. It is not material whether the payment to the assignor is in oil or in cash which is the proceeds of the oil, Helvering v. Twin Bell Syndicate, 293 U. S. 312, 321, nor that some of the payments were in the form of a bonus for the contract. Burnet v. Harmel, 287 U. S. 103, 111; Murphy Oil Co. v. Burnet, 287 U. S. 299, 302. Congress, however, has recognized the peculiar character of the business of extracting natural resources. Leases are a method of exploitation of the land for oil and payments under leases are "income to the lessor, like payments of rent." 10 "10 Receipts from oil sales are gross income to the operator and subject to statutory deductions. Since lessors as well as lessees and other transferees of the right to exploit the land for oil may retain for themselves through their control over the exploitation of the land valuable benefits arising from and dependent upon the extraction of the oil," Congress provided as early as the Revenue Act

8 287 U. S. at 557: "The language of the statute is broad enough to provide, at least, for every case, in which the taxpayer has acquired, by investment, any interest in the oil in place, and secures, by any form of legal relationship, income derived from the extraction of the oil, to which he must look for a return of his capital."

287 U. S. at 558: "Even though legal ownership of it, in a technical sense, remained in their lessor, they, as lessees, nevertheless acquired an economic interest in it which represented their capital investment and was subject to depletion under the statute." Lynch v. AlworthStephens Co., 267 U. S. 364; Burnet v. Harmel, 287 U. S. 103, 109-10; Bankers Coal Co. v. Burnet, 287 U. S. 308; Kirby Petroleum Co. v. Commissioner, supra, p. 603.

• Stratton's Independence v. Howbert, 231 U. S. 399, 413–14. 10 Burnet v. Harmel, 287 U. S. 103, 107-8.

11 See Lynch v. Alworth-Stephens Co., 267 U. S. 364, 370; Palmer v. Bender, 287 U. S. 551, 556.

of 1918 12 for equitable apportionment of the depletion allowance between them to correct what was said to be an existing inequality in the law or its administration."3

In the present case, the assignor of the petitioner before assignment had an economic interest in the oil in place through its control over extraction. Under the contract with petitioner, its assignor retained a part of this interest-fifty per cent of net. Like the other holders of such economic interest through royalties, the petitioner looked to the special depletion allowances of § 114 (b) (3) to return whatever capital investment it had. The cost of that investment to the beneficiary of the depletion under § 114 (b) (3) is unimportant. Depletion depends only upon production. It is the lessor's, lessee's or transferee's "possibility of profit" from the use of his rights over production, "dependent solely upon the extraction and sale of

12 40 Stat. 1057, 1067, 1078, §§ 214 (a) (10), 234 (a) (9).

13 H. Rep. No. 767, 65th Cong., 2d Sess., September 3, 1918, Deductions (5) and for corporations, Deductions (4).

The inequality referred to under the Revenue Act of 1916, 39 Stat. 759, § 5, Eighth (a), arose from the preferred treatment given the owner over the lessee. See Hearings, House Committee on Ways and Means, 65th Cong., 2d Sess., pp. 455, 516-17, 523-28, 530-31. Regulations 33, Income Tax, promulgated January 2, 1918, Art. 170; Regulations 45, 1920 ed., Income Tax, promulgated January 28, 1921, Art. 201.

The applicable law for allowance of depletion in oil and gas wells appears in § 114 (b) (3). It is identical with I. R. C. § 114 (b) (3). This section is the result of administrative experience with oil and gas depletion. Hearings, Sen. Com. on Finance, 69th Cong., 1st Sess., pp. 177-78; Hearings, House Com. on Ways and Means, 69th Cong., p. 1006. See H. Rep. No. 1, 69th Cong., 1st Sess., December 7, 1925, Discovery Value; § 204 (c) (2), 44 Stat. 16. For discussion see Helvering v. Twin Bell Syndicate, 293 U. S. 312, and Kirby Petroleum Co. v. Commissioner, supra, pp. 602, 603. Depletion is now an arbitrary percentage allowance based on production from the wells without regard to cost or value of the property.

the oil," which marks an economic interest in the oil. See Kirby Petroleum Co. v. Commissioner, supra, page 604. Through retention of certain rights to payments from oil or its proceeds in himself, each of these assignors of partial exploitation rights in oil lands has maintained a capital investment or economic interest in the oil or its proceeds." As the oil is extracted and sold, that economic interest in the oil in place is reduced and the holder or owner of the interest is entitled to his equitable proportion of the depletion as rent or royalty. The operator, of course, may deduct such payments from the gross receipts.

Of course, such a transferor, whether the landowner or any intermediate assignor, may completely divest himself of any interest, economic or otherwise, in the extraction of the oil. As the record shows no reservation of an economic interest by Sutton, the assignee of Gulf and the assignor of petitioner, he appears to have done so in this case. See Helvering v. Elbe Oil Land Co., 303 U. S. 372. While, as pointed out above, the payment of proceeds in cash, the form of the instrument of transfer and its effect on the title to the oil under local law are not decisive of the right to participation in depletion under §§ 23 (m) and 114 (b) (3), there must be a determination under federal tax law as to "whether the transferor has made an absolute sale or has retained" such economic interest as we have just described in the preceding paragraph. Kirby Petroleum Co. v. Commissioner, supra, page 606. We have said that the instrument should be construed as a sale when a large cash payment was made with a reserved payment that could be satisfied by future sales of the transferred property without extraction of the oil. Obviously

14 A participation in net profits disassociated from an economic interest does not enable a recipient of such profits to benefit from depletion. Helvering v. O'Donnell, 303 U. S. 370.

there could be no depletion without extraction. Anderson v. Helvering, 310 U. S. 404, 412. On the other hand, 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.

The Government contends that Helvering v. Elbe Oil Land Co., 303 U. S. 372, controls this case. The transfer of the leases in Elbe was held an absolute sale. There the transfer was for cash, deferred payments in cash, if the assignee did not take advantage of a stipulation for abandonment, and a one-third interest in the net profits of the assignee. It was further provided that Elbe, the assignor after the transfer, should have "no interest in or to said properties," except in the case of an abandonment of the property by the assignee. This provision for the transfer of all interest of the assignor was emphasized as a significant part of the agreement for transfer. The issue upon which this Court passed was the classification of the deferred payments. Were they gross income from the property or receipts from a sale of the leases? These deferred payments were not payable out of oil sales but were payable absolutely, unless there was an abandonment. This Court concluded that the addition of a provision for the payment of a share of net profits did not qualify "in any way the effect of the transaction as an absolute sale." Page 375. In view of what we have said in this and in the Kirby Petroleum case as to the economic interest in the oil of a recipient of a share of net profits, the holding of Elbe should not be extended to the facts of this agreement.

The assignor, Gulf, in the assignment here involved, required the grantee to drill promptly, to account for production, to pay over fifty per cent of receipts, less agreed

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Opinion of FRANKFURTER, J.

costs and expenses, and to sell the production on defined terms to grantor, if grantor desired to purchase. This last clause did not appear in the Elbe contract. Such a transfer of rights to exploit could not, we think, properly be construed as a sale. It is rather an assignment to the operator, petitioner here, of the right to exploit the property 15 with a reservation in the assignor of an economic interest in the oil.

Reversed.

MR. JUSTICE JACKSON took no part in the consideration or decision of this case.

MR. JUSTICE BLACK and MR. JUSTICE DOUGLAS dissent.

MR. JUSTICE FRANKFURTER.

The tortuous process by which the result in this case has evidently to be reached by the Court justifies calling attention again to the present unsatisfactory state of tax litigation. It is of course idle to expect that the complexities of our economic life permit revenue measures to be drawn with such simplicity and particularity as to avoid much litigation. But it is not a counsel of perfection to assume that a system of judicial oversight of fiscal administration can be devised sufficiently rational to avoid the unedifying series of cases relating to income from oil operations culminating, for the present at least, in this case. The Court made a brave effort in Dobson v. Commissioner, 320 U. S. 489, to meet some of the difficulties of the present distribution of judicial authority in tax cases by lodging practical finality in a Tax Court decision unless it invokes a "clear-cut mistake of law." Id. at 502. An attempt to give adequate scope to such a doctrine of judicial abstention by dealing with the practicalities of

15 See the discussion of Felix Oil Co. in note 7, supra.