Opinion
No. 71-331
Decided August 1, 1972. Rehearing denied August 22, 1972. Certiorari granted November 27, 1972.
Wyoming residents sought to recover Colorado income taxes paid on royalties they received by virtue of their assignments of oil and gas leases on lands in Colorado. From judgment for taxpayers, director of revenue appealed.
Reversed
1. TAXATION — Oil and Gas Leases — Assignors — Retain Right — Payments — Tangible Property — Income Taxable. Where assignors of oil and gas leases covering lands in Colorado retained the right to obtain money payments for their overriding royalty interests in such lands, that retained right is an interest in tangible property and income therefrom is taxable by the State of Colorado.
Appeal from the District Court of the City and County of Denver, Honorable Sherman G. Finesilver, Judge.
Fairfield and Woods, Peter F. Breitenstein, for plaintiffs-appellees.
Duke W. Dunbar, Attorney General, John P. Moore, Deputy, Eugene C. Cavaliere, Assistant, for defendant-appellant.
L. N. Hagood and Mary C. Hagood, residents of Wyoming, were the lessees of separate oil and gas leases obtained from the United States Department of Interior, covering certain federal lands located in Colorado. Each lease was granted pursuant and subject to the Mineral Leasing Act, 30 U.S.C. § 181, et seq., as amended, which provides in part as follows:
". . . Nothing in this chapter shall be construed or held to affect the rights of the States or other local authority to exercise any rights which they may have, including the right to levy and collect taxes upon improvements, output of mines, or other rights, property, or assets of any lessee of the United States." 30 U.S.C. § 189.
By separate assignment taxpayers assigned their leases to third persons, which assignments were approved by the Department of Interior prior to the tax years in question. The assignments all contain different language but typical is the language in the assignment of the lease by Mary C. Hagood to Stanolind Oil and Gas Company:
"The Assignor hereby reserves out of this Assignment, a royalty at the value, at the field market price at the time of production of two and one-half per cent (2 1/2%) of the oil and gas that may be produced, saved and sold from the above described lease, payment of the same to be made on the 20th day of each month for the oil and gas produced during the preceding calendar month. The overriding royalty retained and reserved by Assignor shall bear its pro rata share of any production or severance tax or any other tax computed, measured or based upon production of oil and/or gas which may be imposed by the Federal Government, the State of Colorado or any of its political subdivisions. Assignee is hereby authorized to and its option may pay all taxes of Assignor and to deduct Assignor's share so paid from the amount of royalties which shall become due. In the event the Assignor's interest is less than the full and undivided ownership in said lease, the royalty to be paid her shall be that percentage of the above amount which her interest bears to the full leasehold estate."
The Colorado Income Tax Act of 1964, as amended, 1965 Perm. Supp., C.R.S. 1963, 138-1-15(2)(b), provides that the Colorado taxable income of a nonresident individual shall be considered derived from sources within Colorado when such income is attributable to, inter alia, "the ownership of any interest in real or tangible personal property in Colorado" and as such shall be taxable by the State of Colorado.
Because of sums paid to taxpayers pursuant to the lease assignments, the Colorado Department of Revenue, by issuance of notice of deficiency, assessed income tax against the taxpayers for the years 1965 and 1966. The tax as assessed was paid under protest, and separate suits were filed by taxpayers to recover the amounts paid. The cases were consolidated for trial in the district court. Each party filed motion for summary judgment and stipulated that the case be decided on such motions.
The trial court ruled that the royalty interests retained by the taxpayers did not constitute an interest in real or tangible personal property in Colorado within the meaning of 1965 Perm. Supp., C.R.S. 1963, 138-1-15, and ordered repayment of the taxes which had been paid under protest. The director has appealed contending that the royalty reserved by taxpayers constitutes an interest in real or tangible property within the meaning of the taxing statute and that the taxpayers' suit should be dismissed. We agree and reverse the judgment.
It is taxpayers' contention that the execution of the federal leases created no tangible property rights in the taxpayers. They further contend that they had executed a complete and non-equivocal assignment of the leases and that as a result of the assignment, if they ever had any tangible property interest by virtue of their being lessees of a federal oil and gas lease, they had retained no interest in the leases or leased property. They maintain that their rights to payment from production from the oil and gas leases rest on a contract with the assignee rather than upon a reserved mineral right; that this contract right was an intangible personal property right; and that income from this intangible personal property right was not taxable to a nonresident of the State of Colorado by the State of Colorado.
In determining the nature of an overriding royalty interest, it is necessary to look at the cases construing the meaning of the word "royalty" without regard to the federal statute and the federal leases, which leases have the effect only of delineating the rights and relationships between the contracting parties.
The majority rule in other states holds that a lessee's interest in a gas and oil lease is an interest in real estate. See Continental Supply Co. v. Marshall, 152 F.2d 300, cert. denied, 327 U.S. 803, 66 S.Ct. 962, 90 L.Ed. 1038 ( Oklahoma lease); Carroll v. Holliman, 336 F.2d 425, ( Texas lease); Callahan v. Martin, 3 Cal.2d 110, 43 P.2d 788. Colorado seems to favor the general rule.
Colorado has held that an oil and gas lease is an interest in real estate for mortgage recording purposes. Brice v. Pugh, 143 Colo. 508, 354 P.2d 1024.
A royalty interest was considered an interest in tangible property in Denver Joint Stock Land Bank v. Dixon, 57 Wyo. 523, 122 P.2d 842, 140 A.L.R. 1270, wherein the court stated:
"The right to a royalty interest in oil does not merely attach after the oil has been severed from the ground and has become personal property. It is not merely rent issuing out of the annual produce of the land. It goes further than that. The right, extending as it does to oil which is to come from particular land, extends to and is necessarily connected with the corpus of the land, and is, accordingly, a right which exists in the oil which still is in place, inchoate though it may be, follows it as it comes from the ground and still is attached after it has become personal property. To call it personal property is but emphasizing a particular stage of the right on its way to fulfillment. It ignores that it is a right which necessarily extends to part of the corpus of the land. If it were possible to divide the oil in the ground in such a manner that the land in which the royalty portion would be found could, together with the royalty interest, be delivered to the owner of the royalty interest intact, then clearly it would be considered as real property."
Taxpayers owned the original leases acquired from the United States Government. They thereby acquired an interest in the land. In transferring their rights in these leases they retained a percentage interest in the production but permitted third parties to extract the oil and gas in which they had an interest. This retained interest was plaintiffs' property under the original lease and continued to be taxpayers' property after the assignment was executed and approved.
[1] The fact that under the assignments from the taxpayers to third parties, the taxpayers did not retain the right to compensation in kind, i.e., the right to retain an interest in the oil and gas extracted, but rather a right to obtain payment in monies for their overriding royalty interest, does not change the nature of the royalty interest. It is payable by determination of field market price at the time of production and is payable from specific production from a specific lease covering specific real property in Colorado. Denver Joint Stock Land Bank v. Dixon, supra. The retained right is an interest in tangible property and the income therefrom is taxable.
Judgment reversed with directions to dismiss plaintiffs' complaints.
CHIEF JUDGE SILVERSTEIN and JUDGE PIERCE concur.