Parkey v. Commissioner ( 1929 )

JAMES R. PARKEY AND SALLIE T. PARKEY, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Parkey v. Commissioner

Docket Nos. 24829, 32620, 32621.

United States Board of Tax Appeals

16 B.T.A. 441; 1929 BTA LEXIS 2589;

May 9, 1929, Promulgated

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1. Certain instruments held to be oil and gas leases and not sales of capital assets within the meaning of section 206 of the Revenue Act of 1921 and section 208 of the Revenue Act of 1924.

2. Royalties received from oil and gas leases on the separate property of a husband held under the facts of these proceedings not to constitute community income under the laws of Texas.

3. The Board will not decide a pure question of law where no facts are admitted or proven upon which a recomputation of the tax can be made.

Robert Ash, Esq., for the petitioners.

L. A. Luce, Esq., for the respondent.

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MILLIKEN

These proceedings were consolidated and involve the redetermination of deficiencies in income tax. In the proceedings of James R. Parkey the deficiencies are for the years 1923 and 1925 in the respective amounts of $2,865.22 and $1,829.15. In the proceeding of Sallie T. Parkey the deficiency is for the year 1923 and in the amount of $12.74.

Petitioner, James R. Parkey, alleges that the respondent erred in refusing to determine that the sale of oil leases on petitioner's land constituted sales of capital assets where the lands were owned for a period in excess of two years, and, in the alternative, that (1) if the sales of such leases were not the sales of capital assets, then they were sales of personal property and as such would be community income in the State of Taxes even though the land itself was separate property of the husband, and (2) if the sales of leases were not sales of capital assets and if they were not sales of personal property, then the bonuses received for leasing the land should be considered as prepaid royalty. Petitioner, Sallie T. Parkey, asserts that the bonuses received for leases on community property should be considered as prepaid royalty. The facts were stipulated and from the stipulation we make the following findings of fact.

FINDINGS OF FACT.

The petitioners, James R. Parkey and Sallie T. Parkey, are residents of Mankins, Archer County, Tex.

James R. Parkey, one of the petitioners herein, acquired in 1888 title in fee simple to certain land in the "american Tribune New Colony Subdivision," "S.P.R.R. Surveys," "H. & T.C. Survey No. 11," and the "Day Land & Cattle Co. Survey" in Archer County, Tex. In that year James R. Parkey, who was unmarried, moved on the said land and engaged in cattle raising and farming. At that time no oil had been discovered in the locality.

Subsequent to 1888 and prior to 1916, the said James R. Parkey married Sallie T. Parkey, the other petitioner herein. In 1916 the said James R. Parkey purchased certain additional land which was a part of the "Dallas County School Lands Subdivision" in Archer County, Texas.

The petitioners were married and lived together during all of the years 1923, 1924 and 1925. Each petitioner filed separate income-tax returns for the said years, including therein certain sums as community income and certain amounts as separate income.

Copies of said "oil and gas leases" are filed in the record. The material provisions of said leases are similar. One of said leases reads:

THIS CONTRACT AND AGREEMENT, made and entered into this the 18th day of January, A.D. 1923, by and between J. R. Parkey, of Archer County, Texas, party of the first part, hereinafter called lessor, and the Texhoma Oil & Refining Company, a corporation, organized and existing under and by virtue of the laws of the State of Texas, party of the second part, hereinafter called lessee, witnesseth;

That the said lessor for and in consideration of the sum of Thirty Seven Thousand Five Hundred ($37,500.00) Dollars, cash in hand paid, the receipt of which is hereby acknowledged, and the further consideration of the payment to lessor of thirty seven thousand five hundred ($37,500.00) Dollars out of the proceeds received from the sale of seven sixteenths (7/16) of the first oil produced and saved from the hereinafter described land, and of the convenants and agreements, hereinafter contained on the part of lessee to be paid, kept and performed, has granted, conveyed, demised, leased and let, and by these presents does grant, demise, convey, lease and let, unto the said Texhoma Oil and Refining Company, for the sole and only purpose of mining and operating for oil and gas, and of laying pipe lines and of building tanks, powers, stations and structures thereon to produce, save and take care of said products, all that certain tract of land situated in the County of Archer, and State of Texas, described as follows to-wit:

* * *

It is agreed that this lease shall remain in force for a term of one (1) year from this date, and as long thereafter as oil or gas, or either of them, is produced from said land by lessee.

In consideration of the premises, the said lessee covenants and agrees.

1. To deliver to the credit of lessor, free of cost, in the tanks or pipe lines to which he may connect his wells, the equal one eighth (1/8) part of all oil produced and saved from the leased premises.

2. To pay the lessor one eighth (1/8) of the value at the well, for the gas from each well where gas only is found, while the same is being used off the premises, and lessor to have gas free of cost from any such 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 well at his own risk and expense.

3. To pay lessor for gas produced from any oil well and used off premises at the rate of one eighth (1/8) of the value at the well, for the time during which such gas shall be used.

4. Lessee agrees to begin the drilling of a well on the above described land as soon as the well now being drilled by it on the Zane Cetti land has been completed or abandoned, and agrees to begin the drilling of a second well within thirty (30) days after the completion of the first well, and agrees to begin the drilling of a third well within thirty (30) days thereafter the completion of the second well.

The first well hereinabove referred to is to be drilled upon the Southwest quarter (SW 1/4) of the Southeast quarter (S.E. 1/4) of said section No. 1 above described.

It is also understood and agreed that each of said above mentioned three wells is to be drilled to a depth of 1800 feet, unless oil or gas is found at a lesser depth and below 1000 ft. In the event oil is found and produced in paying quantities upon the above described land from any well drilled thereon by the lessee, then lessee agrees to develop said lease with due diligence until the same has been fully developed.

If said lessor owns a less interest in the above described land than the entire and undivided fee simple estate therein, the royalties 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 operations therein except water from tanks of lessor.

When requested by lessor, lessee shall bury its pipe lines below plow depth.

No well shall be drilled nearer than 200 feet to the house or barn now on said premises without the 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 either party hereto is assigned and the privilege of assigning in whole or in part is expressly allowed the covenants hereof shall extend to the assigns and successive assigns, but no change in the ownership of the land or assignment of rentals or royalties shall be binding on the lessee until after the lessee has been furnished a written transfer or assignment or a true copy thereof.

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 mortgage taxes, or other liens on the above described lands, in the event of default of payment by lessor, and be subrogated to the rights of the holder thereof.

In testimony whereof, we sign, this the 18th day of January A.D. 1923.

In some of the "oil and gas leases" the nominal rather than the actual consideration paid to petitioners in consideration of the execution of the agreements is stated. The following statement shows the full cash consideration received by the petitioners in the years designated:

Year	Lessee	Exhibit	Lands
1923
Separate	Texhoma	A	S.P.R.R
	W. T. Hoppes	B	Amer. Trib
	Separate property proceeds, 1923.
Community	Empire	C	Dal. Co. Sch. Lds
	Empire	D	Dal. Co. Sch. Lds
	Community property proceeds, 1923.
1925
Separate	A. B. Smith	E	S.P.R.R
	Roy I. Carter	F	Amer. Trib.
	Roy I. Carter	G	H. & T.C.R.R. Co
	Roy I. Carter	H	H. & T.C.R.R. Co
	Roy I. Carter	I	H. & T.C.R.R. Co
	Humble Oil Co	J	Amer. Trib
	Humble Oil Co	K	Amer. Trib
	Humble Oil Co	L	Day Lnd. & Cat
	Empire	M	Amer. Trib
	Empire	N	H & T.C.R.R. Co
	B. O. Sanford	O	Amer. Trib
	Bridwell & Heydrick	P	Amer. Trib
	E. L. Smith Oil Co	Q	H. & T.C.R.R. Co
	K. S. Woolery	R	H. & T.C.R.R. Co
	Empire	S	S.P.R.R. Co
	Separate property proceeds, 1925.
Community	L. E. Wilson	T	Dal. Co. Sch. Lnd
	L. E. Wilson	U	Dal. Co. Sch. Lnd
	V	Dal. Co. Sch. Lnd
	Community property proceeds, owned.
	more than 2 yrs.
	1 I. E. Silkwood, et al	V	Dal. Co. Sch. Lnd
	Other lease sales not in controversy
	(see Agt's rep.
	Community property proceeds.

Year	Acreage	Consideration
1923
Separate	500	$37,500.00
	40	4,000.00
		41,500.00
Community	2,000	15,000.00
	2,000	15,000.00
		30,000.00
1925
Separate	150	5,000.00
	40	3,000.00
	40	3,000.00
	40	7,000.00
	20	3,500.00
	55 1/2	5,550.00
	40	4,000.00
	44 1/2	4,450.00
	80	8,000.00
	80	8,000.00
	120	12,000.00
	60	6,000.00
	40	4,000.00
	80	8,000.00
	80	6,000.00
		87,500.00
Community	40	2,000.00
	40	2,000.00
	280	5,270.09
		9,270.09
	60	1,129.91
		1,123.42
		11,523.42

None of the land conveyed by the above mentioned leases had been under lease within the preceding two years, with the exception of a portion of the land covered by the Silkwood lease as above shown.

The consideration received for executing "oil and gas leases" on land included in the "American Tribune New Colony Subdivision." "S.P.R.R. Surveys," "H. & T.C. Survey No. 11," and "Day Land & Cattle Company Survey" is separate income to the petitioner, James R. Parkey, and the consideration received for executing "oil and gas leases" on land included in the "Dallas County School Lands Subdivision" is community income.

OPINION.

MILLIKEN: Counsel for the respective parties stipulated that the only question before the Board in these proceedings is the proper method of taxing certain monies received by the petitioners as consideration for the execution of certain agreements designated and commonly known in Texas as "oil and gas leases" on certain portions of the land above referred to. Petitioner James R. Parkey contends that respondent erred in not according him the benefit of section 206 of the Revenue Act of 1921 and section 208 of the Revenue Act of 1924. These sections in part provide for the taxation of gains arising from "the sale or exchange of capital assets consummated after December 31, 1921." Section 206(a)(6) of the Revenue Act of 1921 provides:

(6) The term "capital assets" as used in this section means property acquired and held by the taxpayer for profit or investment for more than two years (whether or not connected with his trade or business), but does not include property held for the personal use or consumption of the taxpayer or his family, or stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year.

Section 208(a)(8) of the Revenue Act of 1924 reads:

(8) The term "capital assets" means property held by the taxpayer for more than two years (whether or not connected with his trade or business), but does not include stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale in the course of his trade or business.

The question presented is whether the oil and gas leases executed by petitioners constitute sales of "capital assets" as defined in the sections quoted. Petitioner James R. Parkey contends that under the law of Texas an oil and gas lease" not only conveys the oil and gas in place but also conveys an interest in the realty itself." In support of this contention he cites ; , and ; . He further contends that in applying section 206 of the Revenue Act of 1921 and section 208 of the Revenue Act of 1924 we should be governed by the state law. This same question was presented and the same argument advanced in . We there held that for Federal income-tax purposes the usual oil and gas lease did not constitute a sale of oil and gas in place, that this was true irrespective of the law of the State where the oil and gas were produced; that the proceeds of the oil and gas constitute rentals, and therefore gross income; and that such a lease did not constitute a sale of capital assets within the meaning of section 206 of the Revenue Act of 1921. There is no material difference between the provisions of section 206 of the Revenue Act of 1921 and section 208 of the Revenue Act of 1924 in so far as these sections are applicable to the question before us. We based our opinion in the Berg case on ; ; ; and . It is not necessary again to review these cases, except to point out the they hold that for Federal income-tax purposes an ordinary mineral lease does not constitute a sale of mineral in place and that the proceeds of the minerals going to the lessor are rents.

Subsequent to our decision in the Berg case, the United States District Court for the Eastern District of Pennsylvania rendered its decision in . The facts in that case were that one Weiss, who was the owner of coal lands in Pennsylvania, in the year 1889 entered into a coal lease covering the lands upon a monthly rental reckoned on coal raised and the price realized at the breaker. The questions presented were whether this contract resulted in a sale, as of the date of the lease, of all the coal in place, in which case any gain from the sale was not taxable, since the sale was made prior to March 1, 1913; or whether the proceeds of the sale constituted rents, in which case they were taxable as gross income. The court, after pointing out that it was the established law laid down by the courts of Pennsylvania that such a contract resulted in a sale of the coal in place, and after the reference to the decisions of the Supreme Court which we cited in the Berg case, said:

* * * The conclusion reached is that the courts of the United States do not accept the Pennsylvania view of "so-called mining leases," and that, in the construction of a tax law of the United States, the law of the state in which the land is situate need not be followed, and that "so-called royalties" are income.

This decision was affirmed by the Circuit Court of Appeals for the Third Circuit in , and certiorari was denied by the Supreme Court, . In their opinion the Circuit Court of Appeals said:

It is established beyond question that the law of the state in which property is situated governs federal courts in many things; in descent, alienation and transfer and the effect and construction of wills (); but whether it governs the federal government in the performance of its sovereign power to levy taxes is another question, and is the precise question here.

True, state decisions sometimes control federal legislation, for instance, in determining a deduction allowed by the federal estate tax, but that is because of the express provision - or permission - of the federal act which authorizes deduction of such charges as "are allowed by the laws of the jurisdiction * * * under which the estate is being administered." . But whether the federal government is limited in its selection of subjects for taxation by rules of state courts in respect to property within the state's jurisdiction is another matter and it is one on which the Supreme Court in , did not feel called upon to pass, although the question there, like the one here, was whether royalties or rents were income, and the mere following of the state rule would have been an easy way to decide the question. In that case a Minnesota contract of "lease" substantially like the Pennsylvania contract of "sale" in this case was under consideration. That contract of lease, as the Supreme Court noted, was of a class adjudged by the courts of Minnesota and other states to be a lease as distinguished from the opposite holding by Pennsylvania courts that it is a sale. After quoting the reasoning of Minnesota courts on such instruments, the Supreme Court said in respect to its duty to follow the state rule:

"These conclusions of the Supreme Court of Minnesota are not only made concerning contracts in that state, such as are here involved, but are supported by many authorities. Ordinarily, and as between private parties, there is no question of the duty of the federal court to follow these decisions of the Minnesota Supreme Court, as a rule of real property long established by state decisions. * * * Whether in considering this federal statute we should be constrained to follow the established law of the state, as is contended by the government, we do not need to determine. The decisive question in this case is whether the payments made as so-called royalties amount to income so as to bring such payments within the scope of the Corporation Tax Act of 1909 [36 Stat. 112]."

Such being the question, the Supreme Court itself construed the instrument there in question in order to determine whether the payments that were made under it were proceeds of sale, capital or income. Wholly aside from the construction which the Minnesota courts had placed upon instruments of that kind and solely because of the nature of the payments themselves, the Supreme Court, as we read its opinion, held that the instrument there in question did not effect a sale of the property, that is, of the ore in place (), and that the moneys derived from mining and paid under the instrument were not converted capital, but were royalties or rents, and as such were income, proper to be included in measuring taxes under the applicable revenue act, within the rule of , and .

These cases fully bear out our decision in the Berg case. It is pertinent to point out that the Supreme Court of Texas to a large extent based their decisions in Texas Co. v. Daugherty and Stephens County v. Mid-Kansas Oil & Gas Co., both supra, on Pennsylvania cases. The rule laid down in the Rosenberger case being true as to coal which is fixed in place, it is also true of oil and gas, which are of a fugacious nature.

In , we were again confronted with the same question presented in the Berg case and with the same contention that the state law prevails. Following the Berg decision, we again held that an ordinary oil and gas lease did not convey title to the oil and gas and that such a lease did not constitute a sale of a capital asset within the meaning of section 206 of the Revenue Act of 1921. It is pertinent to point out that the Burkett case resembles these proceedings in that in addition to the usual royalty there was paid a cash consideration of $175,000. The Board's decision in this case was affirmed on March 20, 1929, by the Circuit Court of Appeals for the Eighth Circuitsub nom. . The court said:

* * * The instrument recites that the owners "hereby lease, demise and let" the described land "with the exclusive right of drilling and operating thereon for and producing oil and gas therefrom * * * and also such other privileges as are reasonably requisite for the conduct of said operations, and the right to remove casing from abortive and abandoned wells, and at the termination of this lease to remove all property placed thereon by lessee." The term was for "seven years from the date hereof, and as much longer thereafter as oil or gas * * * are produced from said land. Provided that this lease shall not remain in force longer than fifty years from this date * * *." There were provisions for drilling within stated periods or, failing such, for stipulated payments to the owner (as "rental") or for forfeiture. Other provisions covered royalties on oil or gas produced. $175,000 was paid as consideration for the instrument.

The gist of this instrument is that for a payment of $175,000, the oil company was given the right to prospect and produce oil for a maximum term of fifty years under the conditions and upon the payments set forth therein.

Whether this instrument can be described by any defined legal term - such as lease, license, etc. - it is certain that it is only a limited grant of a right in respect to land and for a limited period of time by one having the fee and possession. Such can not be denominated a sale in the ordinary sense of that word and there is no reason to construe Section 206 as using "sale" in any other sense. The wording and the legislative history of Section 206 are clear that it was intended to apply to "sales" in the sense of conveyance of title to property not of the creation of privileges or estates or rights in property for a limited period of time.

Also, this case is ruled by , and . Both of those cases involved taxing statutes. Those cases defined this character of instruments as grants of privileges and not as conveyances of the mineral (iron ore) in place. We can not see why the character of the instrument is changed or affected by the fact that the mineral is of a character (oil and gas) which was not susceptible of conveyance in place. In either case, the same rights are given and the same results are intended and do follow. What the landowner could or could not grant does not control the nature of what he did grant.

It is clear under the above authorities that petitioner James R. Parkey is not entitled to the benefits of section 206 of the Revenue Act of 1921 and of section 208 of the Revenue Act of 1924.

Next the petitioner, James R. Parkey, contends in the alternative that if the oil and gas leases on his separate estate did not constitute sales of capital assets, then they were sales of personal property and as such would result in community income in the State of Taxas. He makes this contention although it is evident from the record that he has at no time prior to the filing of his petitions herein asserted that these royalties constitute community income and that neither he nor his wife has returned them as community income. Cf. . In fact petitioner has stipulated lated in these proceedings:

The consideration received for executing "oil and gas leases" on land included in the "American Tribune New Colony Subdivision," "S.P.R.R. Survey," "H. & T.C. Survey No. 11," and "Day Land & Cattle Company Survey" is separate income to the petitioner, James R. Parkey * * *.

How in the face of this stipulation this petitioner can now claim that the royalties received from oil and gas produced from his separate property constitute community income is difficult of comprehension. However this may be, it is sufficient to point out that the Court of Civil Appeals of Texas has held in , that such royalties are not community property under Texas laws. The court said:

The land is separate property. The oil in place is realty capable of distinct ownership, severance, and sale. It is a part of the corpus of appellee's sole estate. He conveyed his oil and received, as the principal consideration therefor, one-eighth of the production. No skill, labor, or supervision of either of the spouses, and no community property was expended in the sale or production. The oil and the proceeds thereof received by appellee were neither rent nor profits, within the meaning of the law making such common property, but the consideration for separate realty. Extracting the oil from beneath the surface depletes and exhausts forever the corpus of his separate property; removing it to the top of the ground changes it from real to personal property; but such change or mutation, and the money received, are definitely traced, and, in our opinion, the fund in controversy belonged to appellee in his sole and separate right.

While the above decision is predicated upon a theory which is in conflict with the decisions of the Federal courts on the same question where it has arisen in Federal income-tax cases, nevertheless it is binding on us on the question whether such royalties do or do not constitute community property in Texas. What are the property rights of husband and wife arising from their marital relationship is peculiarly a state question and we are bound on such questions by the decisions of the state courts. Cf. . It is immaterial that a state court in deciding a purely domestic question may advance views which a Federal court would not follow in deciding a purely Federal tax question. Cf. . It is sufficient to say that a Federal income-tax statute can in no way create or modify a marital property right arising under a state law. The first alternative contention of the petitioner, James R. Parkey, must be denied.

Petitioner, James R. Parkey, advances as a second alternative, and petitioner, Sallie T. Parkey, states as her only ground for relief, that the "bonuses received should be considered as prepaid royalty." There is nothing in any one of the petitions, nor in any one of the deficiency letters, nor in the agreed stipulation of facts, which shows how respondent treated such bonuses; neither are we informed by the pleadings nor by the stipulation what result would follow from a redetermination that such bonuses should be considered as prepaid royalties. The relief which petitioners are in fact seeking appears for the first time in the brief filed by their counsel in these proceedings, where he states:

If the Board does not look favorably upon the alternative relief set out as Question (2), we insist that the decisions in the Nelson Land & Oil Company case,, and in the case of , govern. By those decisions the law was firmly established that the bonuses received for executing the leases are prepaid royalties. Being prepaid royalties, the Board should rule that these petitioners are entitled to depletion deduction on account of the said royalties.

On the other hand, counsel for respondent thus states his views of the matter:

The contention of the petitioner that the sums derived from the leasing of the lands constitute a "bonus" or "prepaid royalty" and are therefore not taxable under Sections 210 & 211 of the respective Revenue Acts of 1921 and 1926, has been fully answered by the Board in ;, and the numerous decisions of the Board and the Federal Courts hereinabove cited under Issues (a) and (b).

If petitioners are seeking a deduction for depletion, they should have framed their pleadings so as to cover that issue and then they should have introduced evidence to sustain their allegations. They have done neither. We are not informed whether respondent denied a deduction for depletion in whole or in part, or whether he allowed ample depletion. We are not advised as to cost, value as of March 1, 1913, or discovery value. There are no facts in the record upon which a redetermination of depletion allowance, if granted, can be computed. The function of the Board is to find the facts and to apply the law to the facts found. It does not sit to decide bald questions of law. The Board has consistently refused to pass on questions of law where the facts are insufficient to permit it to dispose of the issues raised. ; . This is true even though by stipulation the parties seek a decision of a pure question of law. . In the absence of proper pleadings and of any evidence bearing on this contention, we are constrained to hold that there is nothing before us for decision.

Reviewed by the Board.

Judgment will be entered for the respondent.

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Footnotes

• 1. This lease included SW. 1/4, Blk. 38, and E. 1/2, SE. 1/4, Blk. 37, Dallas County School Lands, which acreage was under prior lease effective less than two years before this lease the silkwood et al. ↩