Plow Realty Co. v. Commissioner , 4 T.C. 600 ( 1945 )

Hill, J.,

dissenting: The majority holds that petitioner was not a personal holding company within the provisions of section 502 (b) of the Internal Revenue Code for the reason that the income involved does not represent gains “from the sale or exchange of stock or securities.”

Treasury Regulations 103, section 19.502-5, defines “stock and securities” as used in such section as including “certificates of interest or participation in any profit-sharing agreement, or in any oil, gas or other mineral royalty, or lease * * Apparently the majority does not question the validity or interpretative correctness of this provision of the regulations, but holds that the “gains” here involved are not covered by it. I do not agree with this holding.

The burden of the argument of the majority in support of its conclusion is that the instruments of conveyance to Ryan and the Lake Shore Corporation of interests “in and to, all the oil, gas, * * * in, on and under” the described lands were conveyances of title to an interest in the land, namely, a one-fourth interest in the mineral content thereof in place, and were not certificates of interest as specified in the quoted provision of the regulations.

In holding that the instruments in question conveyed interests in realty, namely, undivided interests in the mineral content, the majority relies on two factors, (1) the recital in the granting clause, and (2) the provision that the interests were to continue for 20 years, regardless of the termination of the Shell or other leases. The mere recital in an instrument that it is a debenture does not make it so. We look to the rights enumerated therein. So, here, despite the granting clause, every right and the absence of every right thereafter enumerated indicates clearly that there was no conveyance of undivided interests in the mineral content in place. (1) The “grantee” is given one-eighth of the royalties from the Shell lease, but no part of the annual rentals paid to keep the lease in force. (2) The “grant” runs after 20 years only if and so long as minerals are being produced or mined on the property. If operations cease for any reason despite the continued existence of minerals in place, the “contract” becomes null and void. This provision clearly negatives the idea that the instrument conveys an interest in the mineral content in place. The essence of such a right is the continued ownership of the mineral content, whether or not it is being mined or produced. (3) The “grantee” is expressly given “no interest in any bonus money or rentals received by Grantor in any future lease,” (4) nor does he “acquire any right to participate in the making of future oil, gas or other mineral leases. * * *” If the grantee were an owner of the minerals in place, surely he would have the right to participate in the making of future leases and would share in any and all payments made under such future leases. This express denial of the right to participate in the making of future leases indicates that the majority must be mistaken in saying that “The situation was no different in effect than if petitioner, Ryan and Lake Shore Corporation had joined in the lease.” (5) The “grantee” does not “acquire any right * * * of participating in any rental to be paid for the privilege of deferring the commencement of a well under any lease, now or hereafter.” (6) “It shall not be necessary for the Grantee to join in any such lease or leases so made; * * * Grantee shall receive under such lease or leases one-sixty fourth (%4) part of all oil, gas and other minerals * * * out of the royalty provided for in such lease or leases.”

After this whittling down of the so-called grant it seems clear that all the grantee was given is a share in the royalties and a contract to share in royalties under future leases. The majority may well be right in saying that “clearly the petitioner conveyed more than a mere royalty interest under the existing lease. A royalty interest under that lease would expire with the termination of the lease. * * *” But that something “more” did not amount to an undivided interest in the minerals in place. It amounted solely to a contract right to share in royalties under future leases, which contract right was expressly declared to terminate when minerals cease to be produced or mined, even though they may still be there. These certificates of interest or participation in a profit-sharing agreeement, or in oil, gas, or other mineral royalties or leases, are within the regulations.

Furthermore, even if these instruments were intended to convey rights to the oil and gas in place, the fact that by Texas law such a conveyance is one of realty would not have effect in disturbing the uniform application of the Federal taxing statute. Where instruments of this sort are within the intendment of the Internal Revenue Code and the regulations, state nomenclature may not interfere. The taxing statute and regulations thereunder may not be circumscribed by state nomenclature. In Burnet v. Harmel, 287 U. S. 103, the Supreme Court disregarded for tax purposes the fact that by Texas law an oil and gas lease operates as a present sale of the oil and gas in place. The Court there said (p. 110) :

Here we are concerned only with the meaning and application of a statute enacted by Congress, in the exercise of its plenary power under the Constitution to tax income. The exertion of that power is not subject to state control. It is the will of Congress which controls, and the expression of its will in legislation, in the absence of language evidencing a different purpose, is to be interpreted so as to give a uniform application to a nation-wide scheme of taxation. * * * State law may control only when the operation of the federal taxing act, by express language or necessary implication, makes its own operation dependent upon state law. * * *

“If it is found in a given case that an interest or right created by local law was the object intended to be taxed, the federal law must prevail no matter what name is given to the interest or right by state law.” Morgan v. Commissioner, 309 U. S. 78. As was said in Commissioner v. Fleming, 82 Fed. (2d) 324, 326:

Now in Texas, oil and gas in the ground are capable of ownership and sale separate from the soil which contains them, and leases such as are here involved convey to the lessee title to the oil and gas except such interests as are reserved to the lessor. In Louisiana and many other states this is not true, but the lease only gives the lessee the right to use the land to capture the oil and gas which belong fully to no one until reduced to possession. Nevertheless, in order to give the Federal income tax laws a uniform, operation throughout the United States, these local differences are ignored in dealing with income and ■deductions; * * *

See also Bamma Baucmn, 17 B. T. A. 1312.

Although the majority states that these instruments are not commonly known or referred to as securities, it admits that respondent’s regulation defines “stock or securities” in broad and comprehensive language, and “mineral deeds” have been held to be securities within the meaning of both the Securities Act of Rhode Island and the Federal Securities Act of 1933, and are specifically so designated in the Texas Securities Act. In State v. Pullen, 192 Atl. 473, the court said:

* * * That these oil royalties are, under the law of Texas, deemed to be real estate, and that said “Mineral Deeds” are instruments conveying an interest in realty, is of no importance in our consideration of them in connection with the Securities Act of this State. The mere fact that this deed and this transfer order are treated in Texas as instruments conveying an interest in land does not preclude their being considered in this State also as securities, evidencing an investment in an oil development project.

In Securities and Exchange Commission v. Joiner Leasing Corporation, 320 U. S. 344, 352, the question was whether assignments of oil leases were “securities” within the meaning of section 2(1) of the act, 15 U. S. C., § 77b (1), which provides:

The term “security” means * * * certificate of interest or participation in any profit-sharing agreement, * * * investment contract, * * * fractional undivided interest in oil, gas, or other mineral rights, * * *

In holding the instruments to be securities within this definition, the Court said:

Nor can we agree with the court below that defendants’ offerings were beyond the scope of the Act because they offered leases and assignments which under Texas law conveyed interests in real estate. * * *

Indeed, as was there pointed out in footnote 14, page 354:

In Texas itself, oil and gas leases have been held by the Supreme Court to be securities within the state act, notwithstanding the fact that the act expressly includes only “an interest in or under” such leases. Kadane v. Clark, 135 Tex. 496, 143 S. W. 2d. 197.

Oppee, agrees with this dissent.