Ambassador Petroleum Co. v. Commissioner of Int. Rev.

81 F.2d 474, 17 A.F.T.R. (P-H) 373, 1936 U.S. App. LEXIS 3469

• Court: Court of Appeals for the Ninth Circuit
• Decided: February 5, 1936
• Docket: 7478
• Status: Published

Opinions

GARRECHT, Circuit Judge.

In the present petition to review there are involved income taxes for the calendar year 1925 amounting to $5,972.35, as redetermined in a decision of the Board of Tax Appeals. See 28 B.T.A. 868.

The entire deficiency redetermined by the Board was $6,734.98. In his assignments of error, however, the petitioner asserts that the Board “erred in finding that there was any deficiency for the taxable year in excess of $762.63.” This leaves $5,972.35 as the amount in controversy.

In arriving at the deficiency involved herein, the respondent determined that the “gross income from the property” was $416,630.80, and that the “net income of the taxpayer (computed without allowance for depletion) from the property” was $147,-490.82. The respondent allowed a deduction for depletion amounting to $73,745.41.

Section 204 (c) (2) of the Revenue Act of 1926 (44 Stat. 14) reads as follows:

“(c) The basis upon which depletion, exhaustion, wear and tear, and obsolescence are to be allowed in respect of any property shall be the same as provided in subdivision (a) or (b) for the purpose of determining the gain or loss upon the sale or other disposition of such property, except that — * * *

“(2) In the case of oil and gas wells the allowance for depletion shall be 27% per centum of the gross income from the property during the taxable year. 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 be less than it would be if computed without reference to this paragraph.”

Applying the foregoing provision, the petitioner contends that the correct depletion allowance is $114,573.47, or 27% per cent, of $416,630.80, the “gross income from the property.” The respondent, however, invokes the other provision of the same paragraph; namely, that the depletion allowance shotdd not exceed 50 per cent, of the net income from the property. The respondent computes the net income from the property as being $147,490.82, and 50 per cent, of that sum is $73,745.41, the amount of depletion allowed by him.

The respondent has determined “the net income of the taxpayer * * * from the property” in the following manner:

In addition to deducting from $416,-630.80, which was the “gross income from the property,” the sum of $177,256.70, representing the aggregate of “operating expenses,” the respondent also deducted from such gross income the sum of $91,883.28, representing “development expenses.” It is this latter deduction to which the petitioner excepts.

The two deductions just noted total $269,139.98, leaving the sum of $147,490.-82 as the “net income of the taxpayer (computed without allowance for depletion) from the property.” If the “development expenses” had not been deducted from “gross income from the property,” •the net income from the property would have been $239,374.10, and the maximum limit for the depletion allowance would have been raised to 50 per cent, of that sum, or $119,687.05, instead of the sum of $73,745.41 allowed by the respondent. The depletion allowance of $114,573.47, claimed by the petitioner, would thus have been well within the limit set by the statute.

The question presented therefore resolves itself into whether or not in determining the amount of depletion allowable under section 204 (c) (2) of the Revenue Act of 1926, development expense should be deducted from “gross income from the property” in arriving at “the net income * * * from the property” for the purpose of applying the 50 per cent, limitation provided therein. In other words, it is necessary to ascertain the meaning of the phrase “net income * * * from the property.”

An examination of the administrative and legislative history of the Revenue Act of 1926 and its immediate predecessors will be of assistance in this inquiry.

Section 234 (a) (9) of the Revenue Act of 1921 (42 Stat. 254) reads in part as follows:

“Sec. 234 (a) That in computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions: * * *

“(9) 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, based upon cost including cost of development not otherwise deducted: * * * Provided further, That in the case of mines, oil and gas wells, discovered by the taxpayer, on or after March 1, 1913, and not acquired as the result of purchase of a proven tract or lease, where the fair market value of the property is materially disproportionate to the cost, the depletion allowance shall be based upon the fair market value of the property at the date of the discovery, or within thirty days thereafter: And provided further, That such depletion allowance based on discovery value shall not exceed the net income, computed without allowance for depletion, from the property upon which the discovery is made, except where such net income so computed is less than the depletion allowance based on cost or fair market value as of March 1, 1913; such reasonable allowance in all the above cases to be made under rules and regulations to be prescribed by the Commissioner with the approval of the Secretary.”

Interpreting section 234 (a) (9) of the act of 1921, the Treasury Department’s Regulations 62 contain the following provision :

“Art. 201 (h). Depletion allowance in case of discovery: The deduction for depletion in case of a discovery can not exceed the net income computed without allowance for depletion, from the property upon which the discovery is made, except where and to the extent that such net income so computed is less than the depletion allowance based on cost or fair market value as of March 1, 1913. Net income is the gross income from the sale of all mineral products and any other income incidental to the operation of the property for the production of the mineral products, less operating expenses, including depreciation on equipment, and taxes, but excluding any allowance for depletion. * * *»

It is observable that the foregoing definition of “net income” from the property calls for the deduction of “operating expenses” from the gross income realized from the property, but does not require the deduction of “development expense” therefrom.

On the subject of depletion allowance, the Revenue Act of 1924 contained an important change from the act of 1921. Section 204 (c) of the 1924 statute (43 Stat. 258) read as follows:

“The basis upon which depletion, exhaustion, wear and tear, and obsolescence are to be allowed in respect of any property shall be the same as is provided in subdivision (a) or (b) for the purpose of determining the gain or loss upon the sale or other disposition of such property, except that in the case of mines, oil and gas wells, discovered by the taxpayer after February 28, 1913, and not acquired as the result of purchase of a proven tract or lease, where the fair market value of the property is materially disproportionate to the cost, the basis for depletion shall be the fair market value of the property at the date of discovery or within thirty days thereafter; but such depletion allowance based on discovery value shall not exceed 50 per centum of the net income (computed without allowance for depletion) from the property upon which the discovery was made, except that in no case shall the depletion allowance be less than it would be if computed without reference to discovery value.”

Article 201 (h) of Regulation 65 under the Revenue Act of 1924 defined “net income (computed without allowance for depletion)” from the property precisely as it had been defined in Regulations 62; namely, as being “the gross income from the sale of all mineral products and any other income incidental to the operation of the property for the production of the mineral products, less operating expenses, including depreciation on equipment and taxes, but excluding any allowance for depletion.”

The legislative history of the Revenue Act of 1924 indicates that the term “net income (computed without allowance for depletion) from the property” is synonymous with “operating-profit.” In a “Statement of the Changes Made in the Revenue Act of 1921 by^the Treasury Draft [of the 1924 Act] and the Reasons Therefor,” A. W. Gregg, special assistant to the Secretary of the Treasury, and afterward general counsel of the Bureau of Internal Revenue, said:

“Sec. 204. Paragraph (2) of subdivision (b) supersedes the second and third provisos of section[s] 214 (a) (10) and 234 (a) (9) of the existing law. The existing law limits discovery depletion to the operating profit from the property upon which the discovery is made. The proposed draft limits discovery depletion to 50 per cent of the operating profit [from the property] upon which the discovery has been made. Experience in administering the law has shown that the limitation imposed by the existing law is not a sufficient limitation, and it has been considered that 50 per cent of the operating profit from the property represents a fair limitation upon discovery depletion.” (Italics our own.)

The Gregg Statement appears as Appendix D to Klein’s Federal Income Taxation, at page 308 of the 1929 Edition, with the following explanatory note:

“The value of the statement lies in the fact that not only does it give reasons for the suggested changes, but that it presents clearly the views of one of the best informed men in the country as to the Treasury Department’s interpretation of many difficult points in the 1921 and earlier Acts. It must be stated, however, that Mr. Gregg assumed personal responsibility for the views which he expressed, and emphasized the fact that the statement did not represent an official point of view. Nevertheless, the explanations contained in the statement with respect to the effect and purpose of the suggested changes, most of which were adopted eventually by Congress, are regarded by practitioners as at least quasi-official indications of what Congress intended to enact. Inasmuch as many of the provisions of the 1924 Act, especially the basis and reorganization sections, have been continued in the later Acts, it is highly desirable that the statement referred to be made readily available to practitioners. For that reason it has been presented here.

“A recent decision of the Circuit Court of Appeals, Third Circuit (28 F.(2d) 30 — August 3, 1928 [certiorari dismissed, 278 U.S. 664, 49 S.Ct. 178, 73 L.Ed. 570]), in the case of U. S. v. Whyel, refers to Mr. Gregg’s statement. The reference to the statement, which was immediately followed by the Court’s observation that ‘reports of committees of the House and Senate are regarded as expository [expositive] of the legislative intent in a case where the meaning of a statute is obscure’, leads to the conclusion that the Court took cognizance of the fact that Mr. Gregg’s views had been adopted by Congress.’’ (Italics our own.)

A similar use of the term “operating profit from the property” as synonymous with “net income * * * from the property” is found in the report of the Senate Finance Committee, Senate, 68th Congress, First Session, Report No. 398, p. 20, referred to in Cong. R., vol. 65, part 6, page 617-9.

Indeed, the Commissioner’s own regulations would indicate that he has repeatedly construed “operating profit” as equivalent to “net. income from the property.” In article 201 (f) of Regulations 62, we find the following:

“ ‘Operating profit’ is the net income from mineral production before depletion and depreciation are deducted. It is distinct from net income.”

Similar language is used in the corresponding sections of Regulations 65 and 69, the latter being promulgated under the Revenue Act of 1926, which is the statute applicable to the instant case.

It seems scarcely reasonable to suppose that, in the absence of a specific provision therefor, “development expense” should be deducted in determining “operating profit,” which, as the term indicates, denotes “profit” or “income” from simply the “operation” of the well, without reference to initial outlay. In fact, the respondent concedes that “prior to September 26, 1927, it had been the practice of the Commissioner to disregard development expenses in computing the ‘net income from the property.’ ”

We turn now to the statute specifically tipplicable to the present controversy — the Revenue Act of 1926.

In the 1926 act, the words “the net income of the taxpayer (computed without allowance for depletion) from the property” were employed to designate the yardstick by which the depletion allowance should be measured. Almost identically the same language had been used in the same connection in the Revenue ’Acts of 1921 and 1924. In the 1921 act, however, the limitation of the depletion allowance was 100'per cent, of such income, while in the 1924 and 1926 statutes the limitation was 50 per cent.

It should be borne in mind that when Congress used the term in the 1924 act, it had before it the Report of the Senate Committee on Finance and Gregg’s Statement, supra, in which the expression “operating profit” was used synonymously with “the net income, computed without allowance for depletion, from the property.” Congress also had before it the Treasury Regulation, supra, defining “operating profit” as “the net income from mineral production before depletion and depreciation are deducted,” and carefully distinguishing “operating profit” from “net income” in general, from which latter a deduction for “development, expense” would be proper.

When Congress used the expression “the net income of the taxpayer (computed without allowance for depletion) from the property,” in the Revenue Act of 1926, it had, in addition to all the foregoing regulations and reports, another Treasury Regulation reiterating that “operating profit” is the net amount received from mineral production, etc., and again distinguishing such net “amount” or income from ordinary net income.

It can therefore be seen that the administrative and legislative history of the 1926 statute establishes that “net income * * * from the property” and “operating profit” are synonymous. There is nothing in the Revenue Acts to suggest that “development expense” should be deducted from gross income in order to arrive at “operating profit”; nor does reason point to any such formula.

In addition to section 204 (c) (2), supra, the Revenue Act of 1926 (44 Stat. 41) contains the following pertinent provision:

“Sec. 234 (a) In computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions: * * *

“(8) In the cases of mines, oil and gas wells, other natural deposits, and timber, a reasonable allowance for depiction 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.”

As will be seen from the text of section 204 (c) (2) of the 1926 act, supra, oil depletion based upon discovery value was abandoned, since such allowance “was found difficult of administration.” Helvering v. Twin Bell Oil Syndicate, 293 U.S. 312, 318, 55 S.Ct. 174, 177, 79 L.Ed. 383; U. S. v. Dakota-Montana Oil Co., 288 U. S. 459, 466, 53 S.Ct. 435, 77 L.Ed. 893.

The respondent relies upon certain sections of article 201 of Regulations 69 as authorizing the deduction of development expenses from gross income in determining “net income of the taxpayer (computed without allowance for depletion).” Those sections are as follows:

“Art. 201. Depletion of mines, oil and gas wells; depreciation of improvements. _ * * *

“(c) A 'mineral property’ is the mineral deposit, the development and plant necessary for its extraction, and so much of the surface only as is reasonably expected to be underlaid with the mineral. The value of a mineral property is the combined value of its component parts.

“(d) A 'mineral deposit’ refers to minerals only, such as the ores only in the case of a mine, to the oil only in the case of an oil well, *' * *

“(e) ‘Minerals’ include ores of the metals, coal, oil, gas, and * * *

“(h) ‘Depletion allowance in case of discovery’: The deduction for depletion in case of the discovery of a mine shall not exceed 50 per cent of the net income, computed without allowance for depletion, from the property upon which the discovery is made, except that in no case shall the depletion allowance be less than it would be if computed without reference to discovery value. The phrase ‘net income of the taxpayer (computed without allowance for depletion)’ means the gross income from the sale of all mineral products from the mining property and any other income incidental to the operation of the property for the production of the mineral products, less the deductions in respect to the property upon which the discovery is made, including operating expenses, depreciation, taxes, losses sustained, etc., but excluding any allowance for depletion.” (Italics our own.)

The respondent contends that “development expenses come within the same general class as the deductible items mentioned in the definition and as such should be included in the computation.”

But even if it be conceded that development expenses do come within the same general class as the deductible items specified in paragraph (h), it is clear that such paragraph does not apply to oil wells. Not only are there specific references to “a mine” and to “the mining property,” but the repeated provisions regarding “discovery value” clearly establish that paragraph (h) is applicable only to mines, and not to oil wells; for, as has already been shown, in the 1926 act, discovery value was abandoned with regard to oil wells.

Both “the history of the legislation” and “the administrative construction,” therefore, compel the conclusion that, under the Revenue Act of 1926, in determining the “net income of the taxpayer (computed without allowance for depletion) from the property,” for the purpose of applying the 50 per cent, limitation provided for in section 204 (c) (2), development expenses should not be deducted from gross income.

In U. S. v. Dakota-Montana Oil Co., supra, 288 U.S. 459, at page 466, 53 S.Ct. 435, 438, 77 L.Ed. 893, the court said:

“Thus the acts of 1918, 1921, and 1924 were consistently construed by the regulations to permit a depletion, but not a depreciation allowance for the costs of development work and drilling, which were treated for this purpose either as a part of the cost or an addition to the discovery value of the oil in the ground. The administrative construction must be deemed to have received legislative approval by the re-enactment of the statutory provision, without material change. [Cases cited.]”

The respondent argues that, since the paragraph in question provides that the allowance for depletion “shall not exceed 50 per centum of the net income of the taxpayer (computed without allowance for depletion) from the property,” the rule of expressio unius est exclusio alterius should apply. In other words, the respondent contends that “the specific direction that depletion is to be excluded from the computation in determining net income precludes the exclusion of any other deductible item.” As pointed out, however, in 25 R.C.L. 983: “The maxim -is not of universal application, but is to be applied only as an aid in arriving at intention and not to defeat the apparent intention.”

In specifically excluding the very element sought to be determined — namely, the depletion allowance — Congress was merely giving effect to the axiom that a thing cannot be defined in terms of itself. In view of the legislative and administrative history that we have already traced, we do not think that the requirement that depletion shall not be deducted from gross income in determining net income from the property, implies a corresponding requirement that development expenses shall be deducted from gross income.

The respondent also asserts that “all the Regulations, beginning with those issued under the Revenue Act of 1928, have provided specifically that development expenses are to be deducted in arriving at the net income for the purpose of applying the limitation, and the provision limiting depletion to ‘50 per centum of the net income of the taxpayer (computed without allowance for depletion) from the property’ has been reenacted in the Revenue Acts of 1928, 1932, and 1934.” From this, the respondent reasons that “the argument is compelling that the subsequent re-enactment of the same provision in the Revenue Acts of 1932 and 1934 constituted legislative approval of the Commissioner’s Regulations issued under the Revenue Acts of 1928 and 1932.”

A complete answer to this contention is to be found in the following language contained in the decision in Penn Mutual Life Insurance Company v. Lederer, 252 U.S. 523, 538, 40 S.Ct. 397, 402, 64 L.Ed. 698:

“But no aid could possibly be derived from the legislative history of another act passed nearly six years after the one in question. Further answer to the argument based on the legislative history of the later act would, therefore, be inappropriate.”

Asserting that if the development expenses are not deducted from gross income in arriving at the 50 per cent, limitation, “the practical effect will be the allowance of a double deduction,” the respondent cites Ilfeld Co. v. Hernandez, 292 U.S. 62, 68, 54 S.Ct. 596, 78 L.Ed. 1127, Burnet v. Aluminum Goods Mfg. Co., 287 U.S. 544, 551, 53 S.Ct. 227, 77 L.Ed. 484, and United States v. Ludey, 274 U.S. 295, 301, 47 S.Ct. 608, 71 L.Ed. 1054. The questions of fact and of law involved in those decisions, however, were altogether different from those presented here, and we do not think that those cases support the analogy that the respondent here seeks to draw. In the closing words of the decision in U. S. v. Dakota-Montana Oil Co., supra, 288 U.S. 459, at page 467, 53 S.Ct. 435, 438, 77 L.Ed. 893, the argument of the respondent seems not sufficiently to “consider the administrative and legislative history, which we think decisive.”

Accordingly, in sp far as it redetermines a deficiency in excess of $762.63, the decision of the Board is reversed.