Opinion
No. K-322.
June 5, 1933.
David A. Richardson, of Oklahoma City, Okla. (Samuel W. Hayes, of Oklahoma City, Okla., on the brief), for plaintiff.
George H. Foster and W.W. Scott, both of Washington, D.C., for the United States.
Before BOOTH, Chief Justice, and LITTLETON, WHALEY, WILLIAMS, and GREEN, Judges.
On rehearing. Petition dismissed. For former opinion, see 53 F.2d 907.
This case is now before the court on a new trial granted on plaintiff's motion with respect to the taxability of profits derived by him from the sale of leases acquired from the state of Oklahoma.
At the first trial two questions were presented: First, whether the profits derived by plaintiff from the sale of oil and gas produced from school lands leased by the state of Oklahoma were subject to federal income tax; and, second, whether the profits derived by plaintiff from the sale of such leases on state lands were immune from federal income taxation. We decided the first question in favor of plaintiff in the opinion rendered December 7, 1931, 53 F.2d 907, and entered judgment in his favor for $153,582.38, with interest, which judgment has been paid. See Burnet v. Coronado Oil Gas Co., 285 U.S. 393, 52 S. Ct. 443, 444, 76 L. Ed. 815. The second question was decided in favor of the United States and recovery of the tax paid upon the profits derived by plaintiff from the sale by him of the leases which he had acquired from the state of Oklahoma was denied.
The court makes the following additional special findings of facts with respect to the question now before the court:
1. Prior to 1916, very few leases for oil and gas purposes on its public lands had been offered for sale by the state of Oklahoma. Prior to 1918 the question, whether income derived from the operation of leases on public school lands of the state of Oklahoma and profits derived from the sale of such leases by lessees thereunder, or either such income or profits, were taxable by the federal government, had not been raised in the oil and gas industry, and the bidders for and purchasers of such leases from the state generally bid for and purchased the same without giving consideration to the question whether the income derived by the lessee from the operation of such leases or the profits from the resale thereof would be taxable by the federal government.
2. Since the latter part of 1917, or the first part of 1918, when the question of the nontaxability by the state of Oklahoma of the income and profits of lessees derived from leases upon lands of restricted allottees of the Indian tribes was being raised and decided in suits in the federal courts, a large number of bidders for and purchasers of leases upon public school lands of the state have given consideration to the probability that income derived from the operation of such leases and profits derived from the sale thereof were nontaxable by the federal government, and were influenced by this consideration to bid a greater amount for such leases, and, when successful in their bid, to pay a greater price therefor.
3. The question whether profits from the resale of such leases by the lessees are taxable by the federal government has never been finally settled by the courts; and the question whether the income from the operation of such leases is taxable had never been decided by the Supreme Court of the United States until its decision in the case of Burnet v. Coronado Oil Gas Company, rendered April 11, 1932.
4. Lessees of oil and gas leases in Oklahoma are divided into two well-defined classes. The first class consists of a relatively small number of the larger oil companies engaged, either directly or through their affiliated companies, in carrying on all branches of the oil industry, including the acquisition and development of leases and the production, transporting, refining, and marketing of oil and gas and the products and byproducts thereof. The second, and by far larger class, constituting approximately 90 per cent. of such lessees, consists of individuals and corporations who acquire leases for the purpose of resale and who resell the same in many instances before production has been discovered or exploration has been commenced upon the lease itself. There are only two sources of profit to a lessee from an oil and gas lease: First, profits derived from the resale of the lease before or after some development thereof; second, net income derived from the sale of oil or gas produced by the lessee from the lease. Oil and gas leases, before exploration and development, are highly speculative in character.
The location and commencement of a well upon a geological structure, or upon any one of a block of contiguous leases, substantially increases the market value of all other leases in the block or on the structure in or on which is located the lease on which the well is commenced, the degree of enhancement in value depending largely upon the location of the lease on the structure and its nearness to the exploration well, generally called the test or wildcat well. The discovery of oil in such test well on any lease further greatly enhances the market value of all the leases in the block or upon the structure, the degree of enhancement depending upon the character and amount of production of such well and the location of such other leases upon the structure and their proximity to the well. The bringing in of a producing well upon a lease very greatly increases the market value of such lease, the degree of enhancement in value being determined largely by the amount and character of production of oil found thereon. The resulting increased value of such a lease is sometimes almost fabulous. The drilling of a dry hole on or in the vicinity of a lease always greatly reduces and generally wholly destroys its market value.
5. It is the general and almost universal practice of the members of the oil and gas industry who drill test or wildcat wells to acquire direct from the owners of the lands, or from the original oil and gas lessees thereof, leases covering blocks of acreage upon the same structure or in the vicinity of the proposed location of a test well; and upon the location or commencement of the well, or at some subsequent stage of the exploration and development, sometimes before and sometimes after the completion of the test well, to sell off undivided interests in the leased acreage, so acquired in the block, or entire leases or parts thereof, at the enhanced market value, thereby financing the cost of drilling such test well, or of a part thereof, and, where such sales are made before completion of the well, reducing the risk of loss from such exploration. Such method of financing the cost of such exploration is in many instances the lessee's only means of financing the same.
6. By far the greater number of bidders for and purchasers of oil and gas leases from the state of Oklahoma upon its public school lands belong to the second class mentioned in finding 4. Ninety per cent. or more of such bidders and purchasers have been and are of that class. Approximately 90 per cent. of the leases sold by the state or some interest therein are resold by the state's lessees, and many of such leases are sold several times. From the year 1915 to 1931, inclusive, the state offered for sale and sold 2,841 oil and gas leases on its public lands. During the same period there were 3,092 sales or assignments of such leases by lessees. In many cases the entire interest of the lessee in the lease was sold and assigned. In others only an undivided interest therein, or the entire interest of the lessee under the lease upon a portion, but not upon the whole acreage covered by the lease, was sold. With only few exceptions, leases for oil and gas purposes on the lands of the state have been in the past and are now, as provided by statute, offered for sale by the state in tracts of 160 acres or less, upon sealed bids, to the highest bidders for cash. Such leases reserve to the state a fixed royalty of one-eighth of the oil and gas produced thereunder. Ninety per cent. or more of the bidders for and purchasers of such leases from the state have been persons and corporations who buy and resell leases rather than persons and corporations who acquire leases and hold and develop them to produce and sell the oil therefrom.
7. If the profits derived from the resale of such leases by the lessees of the state are held subject to income and excess profit taxes by the federal government, that holding will have the effect to restrict and limit substantially the market for such leases, and to substantially lessen the price obtainable by the state therefor.
8. Of the public lands of the state of Oklahoma, approximately 700,000 acres have been reserved from sale as lands probably valuable for oil and gas purposes and for leasing for such purposes by the state. Of these lands, approximately 200,000 acres have been heretofore leased and are now under lease for oil and gas purposes. Approximately 500,000 acres thereof are held by the state and reserved from sale for the purpose of leasing the same for oil and gas purposes from time to time as and when it can do so to the best advantage.
9. The only sources of revenue to the state from its public lands because of their mineral character are, first, the bonus or fixed price for which the state can and does sell leases thereon; second, the royalty reserved in the leases sold by the state of one-eighth of the oil and gas produced therefrom; third, an annual rental of $1 per acre for each year after the first year during which the commencement of a well upon such leases is deferred, the fixed term of which leases is five years, unless oil or gas is sooner produced thereon. From all three of these sources of revenue the state of Oklahoma has received between ten and eleven million dollars, of which amount approximately $6,000,000 has been received as bonuses for the cash price paid by the purchaser of the leases, and the remainder thereof, in the approximate sum of $5,000,000, has been received as royalties out of production of oil and gas and as rentals under the leases for the privilege of delaying commencement of wells thereon.
10. The income and excess profit taxes for the year 1917, assessed against and collected from plaintiff upon and because of $214,707.92 of net income from the sale of oil and gas produced by him on section 36, township 20 north, range 5 east, Pawnee county, Okla., under a lease of August 14, 1912, and the interest paid by him thereon has, during the pendency of this proceeding, been refunded and repaid by the Treasurer of the United States.
11. The tax assessed against and collected from plaintiff for 1918 upon and because of net income of $50,653.48 derived by him during that year from the sale of oil and gas produced by him on section 36, township 20 north, range 5 east, Pawnee county, Okla., under the lease of August 14, 1912, and interest thereon, has been during the pendency of this proceeding refunded and repaid to plaintiff by the Treasurer of the United States.
12. If the plaintiff's net income of $377,320.55 received by him during 1918 as net profits on the sale of the oil and gas leases of July 16, 1918, as set forth in finding 4 of the original findings of the court on December 7, 1931, and his net income of $2,218,445.53 received during 1919 as net profits on the sale of the leases of July 16, 1918, as set forth in finding 5 of the original findings of December 7, 1931, is not taxable by the United States, plaintiff is entitled to judgment for $927,314.19, with interest, as provided by law. However, if such income received by plaintiff during 1918 and 1919 as profits from the sale of the oil and gas leases of July 16, 1918, was subject to tax, plaintiff is not entitled to recover, and the defendant is entitled to judgment and to dismissal of the petition.
Plaintiff's motion for a new trial on the question whether the profits derived by him from the sale of leases theretofore acquired from the state of Oklahoma were subject to federal income tax was allowed with leave to take additional testimony with respect to this question. Additional evidence was taken, and we have made additional special findings of facts as requested by the parties.
Plaintiff relies in general upon the principle announced in Gillespie v. State of Oklahoma, 257 U.S. 501, 42 S. Ct. 171, 66 L. Ed. 338, and applied in Burnet v. Coronado Oil Gas Co., supra, and contends that the rule laid down by the court in these cases entitles him to judgment under finding 7 herein that, "if the profits derived from the resale of such leases by the lessees of the State are held subject to income and excess profits taxes by the Federal Government, that holding would have the effect to restrict and to limit substantially the market for such leases, and to substantially lessen the price obtainable by the State therefor." He claims that the case of Willcuts v. Bunn, 282 U.S. 216, 51 S. Ct. 125, 129, 75 L. Ed. 304, is also an authority in his favor upon the principle upon which he relies for the reason that in that case the court said: "Before we can restrict their [the taxing acts'] application upon the ground of a burden cast upon the state's borrowing power, where the tax is not laid upon the contracts made by the State in the exercise of that power, or upon the amounts payable thereunder, but is laid upon the result of distinct transactions by private owners, it must clearly appear that a substantial burden upon the borrowing power of the State would actually be imposed. * * * Before the power of the Congress to lay the excise tax in question can be denied in the view that it imposes a burden upon the State's borrowing power, it must appear that the burden is real, not imaginary; substantial, not negligible."
He therefore contends that the tax here in question must be held invalid on the ground that under the facts it has been made to appear that it casts a substantial burden upon the state's leasing power, and that its effect is to hamper the state's efforts to make the best terms possible for its public schools, a function strictly governmental in character. The defendant also relies upon the case of Willcuts v. Bunn, supra, as authority for its position that the profits on the sale of the leases are subject to federal taxation.
We have again carefully considered this question in the light of the additional facts established on the new trial, and in the light of the reargument and the authorities cited by the parties in support of their respective positions, and have again come to the conclusion announced in the opinion of December 7, 1931, that plaintiff is not entitled to recover and that the petition must be dismissed.
In Group No. 1 Oil Corp. v. Bass, 283 U.S. 279, 51 S. Ct. 432, 433, 75 L. Ed. 1032, the court had before it the question of the taxability of profits derived from oil leases on public lands of Texas. In that state, unlike Oklahoma, the granting of a lease on oil and gas lands constitutes a sale of oil and gas located beneath the surface. The case therefore was one of a claimed immunity from taxation because of the source of the title. The court, while recognizing that the state's property before sale could not be taxed by the federal government, nor could the sale thereof be taxed, said:
"But it does not follow that the same property in the hands of the buyer, or his use or enjoyment of it, or the income he derives from it, is also tax immune. City of New Brunswick v. United States, 276 U.S. 547, 48 S. Ct. 371, 72 L. Ed. 693; Forbes v. Gracey, 94 U.S. 762, 24 L. Ed. 313; Tucker v. Ferguson, 22 Wall. 527, 22 L. Ed. 805; see Weston v. Charleston, 2 Pet. 449, 468, 7 L. Ed. 481; Veazie Bank v. Fenno, 8 Wall. 533, 547, 19 L. Ed. 482. Theoretically, any tax imposed on the buyer with respect to the purchased property may have some effect on the price, and thus remotely and indirectly affect the selling government. We may assume that, if the property is subject to tax after sale, the governmental seller will generally receive a less favorable price than if it were known in advance that the property in the hands of later owners, or even of the buyer alone, could not be taxed.
"But the remote and indirect effects upon the one government of such a nondiscriminatory tax by the other have never been considered adequate grounds for thus aiding the one at the expense of the taxing power of the other. See Willcuts v. Bunn, 282 U.S. 216, 231, 51 S. Ct. 125, 75 L. Ed. 304; Educational Films Corp. v. Ward, 282 U.S. 379, 51 S. Ct. 170, 75 L. Ed. 400; Metcalf Eddy v. Mitchell, 269 U.S. 514, 523, 524, 46 S. Ct. 172, 70 L. Ed. 384. This Court has consistently held that, where property or any interest in it has completely passed from the government to the purchaser, he can claim no immunity from taxation with respect to it, merely because it was once government owned, or because the sale of it effected some government purpose. City of New Brunswick v. United States, supra; Forbes v. Gracey, supra; Tucker v. Ferguson, supra; see Gromer v. Standard Dredging Co., 224 U.S. 362, 371, 32 S. Ct. 499, 56 L. Ed. 801; Choctaw, O. G.R. Co. v. Mackey, 256 U.S. 531, 537, 41 S. Ct. 582, 65 L. Ed. 1076; Central Pacific R. Co. v. California, 162 U.S. 91, 125, 16 S. Ct. 766, 40 L. Ed. 903; Union Pac. Railroad Co. v. Peniston, 18 Wall. 5, 35-37, 21 L. Ed. 787; Weston v. Charleston, supra, page 468 of 2 Pet. [ 7 L. Ed. 481]."
The court recognized the principle of the Gillespie Case, but, upon the basis that the property had passed to the buyer, held that the limits of the immunity had been exceeded. The income from the oil and gas produced was held in that case subject to tax by the federal government.
In Susquehanna Power Co. v. State Tax Commission of Maryland (No. 1), 283 U.S. 291, 51 S. Ct. 434, 435, 75 L. Ed. 1042, immunity was claimed from state taxation because of the use of property otherwise taxable, pursuant to and in connection with a license from the federal government. The court in denying the claim for immunity said: "Assuming, for present purposes, that the license of the Power Commission is a federal instrumentality, immune from taxation or other direct interference by the state, it does not follow that the property appellant uses in its power project is clothed with that immunity. The exemption of an instrumentality of one government from taxation by the other must be given such a practical construction as will not unduly impair the taxing power of the one or the appropriate exercise of its functions by the other. * * *"
In the case of the Indian Motocycle Co. v. United States, 283 U.S. 570, 51 S. Ct. 601, 604, 75 L. Ed. 1277, the court reaffirmed the principle of immunity and applied it in that case which involved a tax levied on the sale of motorcycles to a municipal corporation for use in its police service, and distinguished the case of Willcuts v. Bunn, supra, as follows: "* * * For the taxes there in question were not laid on transactions involving an exertion of governmental functions and their bearing on governmental operations was so indirect or remote as to place them outside the principle which is applicable here."
In Burnet v. Coronado Oil Gas Co., supra, the court applied the principle announced in the Gillespie Case and held that income derived from the sale of oil and gas produced from lands leased from the state of Oklahoma was exempt from tax, but indicated that the principle should not be extended. It was there said that: "We are disposed to apply the doctrine of Gillespie v. Oklahoma strictly and only in circumstances closely analogous to those which it disclosed. * * *"
In Fox Film Corporation v. Doyal, 286 U.S. 123, 52 S. Ct. 546, 547, 76 L. Ed. 1010, the court declined to apply the principle of immunity where the burden upon the state was indirect and remote. In this case the court said: "The principle of the immunity from state taxation of instrumentalities of the federal government, and of the corresponding immunity of state instrumentalities from federal taxation — essential to the maintenance of our dual system — has its inherent limitations. It is aimed at the protection of the operations of government (McCulloch v. Maryland, 4 Wheat. 316, 436, 4 L. Ed. 579), and the immunity does not extend `to anything lying outside or beyond governmental functions and their exertion.' (Indian Motocycle Co. v. United States, 283 U.S. 570, 576, 579, 51 S. Ct. 601, 603, 75 L. Ed. 1277). Where the immunity exists, it is absolute, resting upon an `entire absence of power' (Johnson v. Maryland, 254 U.S. 51, 55, 56, 41 S. Ct. 16, 65 L. Ed. 126), but it does not exist `where no direct burden is laid upon the governmental instrumentality, and there is only a remote, if any, influence upon the exercise of the functions of government' (Willcuts v. Bunn, 282 U.S. 216, 225, 51 S. Ct. 125, 127, 75 L. Ed. 304)."
The immunity from taxation applies only where the tax would be a real and direct burden upon the state's exercise of its governmental functions, and it is our opinion that under the cases cited the burden upon the state of Oklahoma in leasing its public lands on the best possible terms, because of the tax that may be exacted from the lessee upon the sale by him of his leases from the state, is so indirect and remote as to place it outside the principle that one government may not levy a tax upon the functions or instrumentalities of another. Although it is shown in this case that a lessee of oil lands from the state of Oklahoma would pay more to the state for a lease in the first instance, if he were assured that profits from the sale of a lease would be exempt from federal income tax, this was doubtless true in Group No. 1 Oil Corp. v. Bass, supra.
The tax offends the implied constitutional prohibition only if it is imposed directly upon a governmental instrumentality, or if, though it is not so imposed, its effect is to place a direct and substantial burden upon the exercise of a governmental function. Willcuts v. Bunn, 282 U.S. 216, 51 S. Ct. 125, 75 L. Ed. 304; Metcalf Eddy v. Mitchell, 269 U.S. 514, 46 S. Ct. 172, 70 L. Ed. 384. A gain derived by a taxpayer through a sale of property or interest therein acquired from a state, whether acquired in the form of a lease or by purchase, does not, in our opinion, fall within the implied constitutional prohibition against taxation. "The immunity does not extend to anything lying outside or beyond governmental functions and their exertion. * * *" Indian Motocycle Co. v. United States, supra. The immunity from taxation extends only to those agencies through which the state immediately and directly exercises its sovereign powers, and it is apparent that not every one who uses his property or derives a profit, as a result of his dealings with the government, may clothe himself with immunity from taxation. Metsalf Eddy v. Mitchell, supra.
Plaintiff is not entitled to recover and his petition is dismissed. It is so ordered.
WHALEY, WILLIAMS, and GREEN, Judges, concur.
BOOTH, Chief Justice, did not hear this case on account of illness, and took no part in its decision.