Opinion
Docket No. 24325.
1952-06-26
LEDANOIS LAND & STONE COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Fred S. Weis, Esq., for the petitioner. J. Frost Walker, Esq., for the respondent.
The petitioner owned land which it leased for the production of oil and gas. The lease, in addition to providing for a royalty to the petitioner of one-sixth of all oil produced and saved from the land, also provided that the lessee should have free use of oil from the land for all operations under the lease and that the royalty on oil should be computed after deducting any so used. Oil royalty paid to and accepted by the petitioner was computed on the net amount of oil produced and remaining after deduction of the oil used for fuel in drilling oil wells on the property. Held, that under the lease the petitioner retained no royalty interest in the oil used for fuel and that it is not entitled to a depletion allowance computed on one-sixth of the fair market value of the oil so used. Fred S. Weis, Esq., for the petitioner. J. Frost Walker, Esq., for the respondent.
The respondent determined deficiencies of $1,220.87 and $576.96 in the petitioner's excess profits tax for 1943 and 1944, respectively. The petitioner has abandoned all issues raised in its petition except one, namely, the correctness of the respondent's disallowance for 1943 of a deduction of $719.02 taken as depletion on oil produced by petitioner's lessee from the leased premises and used by it in drilling oil wells thereon.
FINDINGS OF FACT.
A portion of the facts were stipulated and are found accordingly.
The petitioner is a Louisiana corporation and filed its income and excess profits tax returns for 1943 and 1944 with the collector of internal revenue at New Orleans, Louisiana.
On June 6, 1941, the petitioner, as lessor, entered into an oil and gas lease with the Texas Company, as lessee, covering approximately 545 acres of land owned by petitioner and situated in Evangeline Parish, Louisiana. The lease contained the following:
1. Lessor in consideration of Fifteen Thousand ($15,000.00) & 00/100 Dollars, Cash, and of Lessee's obligation to drill a well, or wells, as hereinafter provided in detail, of the royalties and oil payments herein provided and of the agreements of Lessee herein contained, hereby grants, leases and lets exclusively until Lessee for the purpose of investigating, exploring, prospecting, drilling and mining for and producing oil, gas, distillate, and other liquid hydrocarbons, for laying pipe lines, building, tanks, power stations, telephone lines and other structures thereon to produce, save, take care of, treat, transport and own said products, and for housing Lessee's employees, the following described lands * * * :
(Here follows a description of the land.)
4. The royalties to be paid by Lessee are:
(a) On Oil, Distillate and other Hydrocarbons which are produced at the well in liquid form by ordinary production methods, One-sixth (1/6th) of that produced and saved from said land, same to be delivered at the well, or to the credit of Lessor into the pipeline to which wells may be connected; the Lessee from time to time may purchase any royalty oil or other liquid hydrocarbons in its possession, paying the market price thereof prevailing for the field where produced, on the date of purchase; * * *
10. Lessee shall have the free use of oil, gas and water from said land, except water from Lessor's well for all operations hereunder, and the royalty on oil and gas shall be computed after deducting any so used. * * *
In drilling oil wells during 1943 under the lease the Texas Company used as fuel 12,200.80 barrels of oil produced from the land covered by the lease. The market value of said oil was $15,687.81.
During 1943 the petitioner received $23,834.36 from the Texas Company as oil royalty produced under the lease.
In its corporation income and declared value excess-profits tax return for 1943 the petitioner stated that the return was made on the cash receipts and disbursements basis. In that return the petitioner reported $26,448.99 as oil royalty received in 1943 under the lease. That amount was composed of the oil royalty of $23,834.36 actually received under the lease during the year and $2,614.63, which represented one-sixth of $15,687.81, the fair market value of the oil produced from the leased land and used as fuel by the Texas Company in drilling oil wells on the land. In computing the net income reported the petitioner deducted under ‘Other Deductions‘ the amount of $2,614.63 as the ‘Value of oil used for fuel in developing property‘ and also deducted as depletion 27 1/2 per cent of the $26,448.99 which had been reported as oil royalty income.
In determining the deficiency the respondent made no change either in the amount of royalty reported as income under the lease, $26,448.99, or in the deduction of $2,614.63 taken as the value of oil used for fuel in developing the property. However, he disallowed $719.02 of the deduction taken for depletion, or 27 1/2 per cent of $2,614.63, which the petitioner included in income as one-sixth of $15,687.81, the fair market value of the oil used for fuel.
OPINION.
TURNER, Judge:
As stipulated by the parties, the only issue submitted for determination is the correctness of the respondent's disallowance of the $719.02 taken as a deduction for depletion. Taking the position that under the lease it was entitled to receive one-sixth of all oil produced and saved from the land, the petitioner contends that in addition to the depletion deduction allowed it with respect to the oil for which it actually received cash royalty, it is also entitled to deduct as depletion 27 1/2 per cent of one-sixth of the fair market value of the oil used for fuel by the lessee in its operations under the lease. In support of its contention the petitioner urges that under the applicable provisions of the Internal Revenue Code the lessor's allowance for percentage depletion is not to be determined on the basis of the amount of actual cash received as royalty under the lease but on the basis of all the oil removed from the land irrespective of whether the royalty oil is sold for cash or is otherwise disposed of. Pertinent provisions of the Code are set out below.
SEC. 23. DEDUCTIONS FROM GROSS INCOME.In computing net income there shall be allowed as deductions:(m) DEPLETION.— 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 deductions shall be equitably apportioned between the lessor and lessee. * * *For percentage depletion allowable under this subsection, see section 114(b)(3) and (4).SEC. 114. BASIS FOR DEPRECIATION AND DEPLETION.(b) BASIS FOR DEPLETION.—(1) GENERAL RULE.— The basis upon which depletion is to be allowed in respect of any property shall be the adjusted basis provided in section 113(b) for the purpose of determining the gain upon the sale or other disposition of such property, except as provided in paragraphs * * * (3) * * * of this subsection.(3) PERCENTAGE DEPLETION FOR OIL AND GAS WELLS.— In the case of oil and gas wells the allowance for depletion under section 23(m) shall be 27 1/2 per centum of the gross income from the property during the taxable year, excluding from such gross income an amount equal to any rents or royalties paid or incurred by the taxpayer in respect of the property. Such allowance shall not exceed 50 per centum of the net income of the taxpayer (computed without allowance for depletion) from the property, except that in no case shall the depletion allowance under section 23(m) be less than it would be if computed without reference to this paragraph.
The respondent contends that under the terms of the lease the petitioner was to receive only one-sixth of the net amount of production remaining after deduction of the oil used by the lessee for operations under the lease and that accordingly the petitioner is not entitled to any depletion deductions with respect to the fair market value of the oil used for such purpose.
While a lessor is entitled to a depletion allowance on royalties paid by the lessee, irrespective of whether paid in cash or in oil, Helvering v. Twin Bell Oil Syndicate, 293 U.S. 312; Kirby Petroleum Co. v. Commissioner, 326 U.S. 599, the petitioner here is claiming depletion on oil on which, under the terms of the lease, no royalty was payable or was paid by the lessee. The pertinent portions of the lease relating to oil royalty are found in paragraphs 4 and 10 and are set out in our findings. Standing alone, the provisions of paragraph 4 indicate that petitioner was to receive a royalty of one-sixth of the oil produced and saved from the land. But paragraph 10 contains the further provision that the ‘Lessee shall have the free use of oil * * * from said land, * * * for all operations hereunder, and the royalty on oil * * * shall be computed after deducting any so used.‘ In view of the latter provision it is our opinion that under the lease the only royalty interest the petitioner retained in the oil was one-sixth of that produced and saved and remaining after deduction of the oil used by the lessee for its operations under the lease. The lessee acquired all other interest in the oil. From the meager facts of record bearing on the matter the foregoing construction appears to have been the one placed on the lease by the petitioner and the lessee in the calculation of the amount of royalty payable and paid to the petitioner during the taxable year.
Since under the lease the petitioner retained no royalty interest in the oil used for fuel and the respondent appears to have allowed the petitioner a depletion allowance of 27 1/2 per cent of the royalties received during the year, we are unable to find that it is entitled to any greater depletion allowance than has been allowed.
Decision will be entered for the respondent.