This is a befit for refund of Federal income taxes for the year 1952 in which the ultimate question presented is whether the amounts paid by taxpayer to transferors of “ anoint allowables ” establish royalties so that, under department 114 ( b-complex vitamin ) ( 3 ) of the Internal Revenue Code of 1939, such payments must be excluded from gross income before computing taxpayer ‘s depletion allowance. The answer to this question depends on whether the assignors of the allowables had a depletable “ economic interest ” in the oil in place with respect to the petroleum produced under these allowables. Taxpayer asserts it is the entirely one entitled to claim depletion. The politics urges that the transferors of the allowables have the needed “ economic concern ” to entitle them to share in the depletion deduction allowed by section 23 ( molarity ) of the Internal Revenue Code of 1939. It is not disputed that either the taxpayer or the transferors ( but not both ) is entitled to claim depletion with respect to the amounts paid to the transferors for these allowables. section 114 provides in apposite separate as follows :
“ § 114. basis for disparagement and depletion. * * *
“ ( boron ) basis for Depletion. — * * *
“ ( 3 ) percentage depletion for Oil and Gas Wells. In the font of oil and accelerator wells the allowance for depletion under section 23 ( megabyte ) shall be 27½ per centum of the gross income from the property during the taxable year, excluding from such arrant income an amount peer to any rents or royalties paid or incurred by the taxpayer in respect of the place. * * *. ” section 23 provides in apposite part as follows :
“ § 23. Deductions From Gross Income. In computing net income there shall be allowed as deductions : * * *
“ ( thousand ) Depletion. In the casing of mines, petroleum and gasoline wells, other natural deposits, and timbre, a reasonable allowance for depletion and for disparagement of improvements, according to the curious conditions in each encase ; 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 leaseholder. * * * ”
For share depletion allowable under this subsection, see incision 114 ( bel ), ( 3 ) and ( 4 ). During the year 1952, Tidewater was the owner and operator of diverse oil and gas leases located in the East Texas Oil Field. That Field is under the control and supervision of the Texas Railroad Commission, which exercises authority over oil and flatulence drill and production operations in the State of Texas. The Railroad Commission makes monthly determinations of the number of barrels of petroleum which can be produced from each well. Each well in the Field is assigned an allowable in barrels per producing day by the Railroad Commission. In addition to the proration of the phone number of allowable barrels to be produced per well, the Railroad Commission besides establishes the number of days each calendar month during which each well can produce. The sum therefore fixed is referred to as the “ permissible ” for each well.

The read discloses that the East Texas Oil Field is about 42 miles long ( north to south ) and 4 to 8 miles wide ( east to west ). The Field has been described as a boastfully pool or reservoir of oil, having a natural water drive from west to east produced by encroaching subterraneal body of water which bounds the field on the west. Bottom-hole pressure, which forces oil to the come on through the wells drilled in the field, is created and maintained by this natural water system drift. The extent and ease of production of oil are determined in the main by the water-oil contact. As oil is withdrawn, water system moves from the west to replace it and sweeps the anoint along in the march. arsenic early on as 1938, it was realized that withdrawal of salt body of water from the field must be curtailed both to prevent a drop in bottom-hole pressure ( which would reduce entire recoverable vegetable oil reserves and increase production costs ) and to prevent pollution of fresh water supplies. Two methods of achieving this solution were developed. The beginning was to encourage reinjection of salt water into the playing field ; the second was to encourage owners and operators to close wells producing excessive amounts of salt water and transfer production to other wells in the field which were not producing salt body of water. These assignable rights to produce are referred to as “ salt-water invalid allowables. ” An operator who reinjected strategic arms limitation talks water that had been produced, or who engaged person to do it for him, was given an extra oil allowable for reinjecting salt water into the reservoir. An operator who closed down a well producing more than 100 barrels of salt water a sidereal day was permitted, beginning in 1942, to transfer his permissible to other wells on the same rent, and late was permitted, beginning in 1947, to transfer the allowable to other operators in the East Texas Oil Field. It is the second method which gives wax to the problem involved in this shell. By club dated July 10, 1947, the Railroad Commission permitted the operator of any well in the airfield producing 100 or more barrels of water a day, to shut in that well and transfer its “ allowable ” to another well or wells producing less than 25 percentage water. The transfer allowable would be added to the transfer ‘s existing permissible to increase production from the transferee ‘s well or wells to the extent of the allowable transfer. After the transfer allowable ceased, the transferor operator could reopen the invalid well and resume production under the applicable Railroad Commission Order if it chose to do then. Taxpayer acquired from other unrelated operators a act of such salt water invalid allowables, and during the year 1952 a helping of taxpayer ‘s production of oil from its leases in the East Texas Oil Field was under these acquired allowables. Under the typical grant of a introvertish allowable, the assignor sold all of its rights to its allowable on specific wells and agreed that all of the anoint produced by the assignee under the permissible should be property of said assignee. The assignee ( taxpayer ) agreed to pay assignor a express price per barrel, which varied with the station sales monetary value “ for each and every barrel of such transferred allowable which assignee produces * * *. ” See finding 11 where a typical appointment of a introvertish allowable is set out. [ Finding 11 set out in Appendix. ] In its tax return for 1952, taxpayer did not claim depletion on the amounts paid to assignors ; this amount was excluded from crude income in determining the base for depletion. Taxpayer belated filed a timely claim for refund, asserting it was entitled to claim depletion on this sum. That claim was denied, and this suit followed. As stated earlier, the decision in the case at bar turns on the question whether the transferors of the allowables have the needed “ economic interest ” to entitle them to contribution in the depletion discount allowed by section 23 ( megabyte ) of the 1939 Code. The “ economic sake ” concept, which is used in defining the intend beneficiaries of percentage depletion, was originally formulated by the Supreme Court in Palmer v. Bender, 287 U.S. 551, 53 S.Ct. 225, 77 L.Ed. 489 ( 1933 ). The Court, mindful of the necessity of creating a uniform law of tax mugwump of the complexities of local law, freed the veracious to depletion allowance from “ any particular form of legal concern in the anoint well ” and reasoned that

“[t]he language of the statute is broad enough to provide, at least, for every case in which the taxpayer has acquired, by investment, any interest in the oil in place, and secures, by any form of legal relationship, income derived from the extraction of the oil, to which he must look for a return of his capital.” [ 287 U.S. at 557, 53 S.Ct. at 226]

As pointed out recently in Commissioner v. Southwest Exploration Co., 350 U.S. 308, 76 S.Ct. 395, 100 L.Ed. 347 ( 1956 ), the two requisites of an economic concern established by Palmer v. Bender, above, are ( 1 ) that the taxpayer must have acquired by investment an sake in the mineral in topographic point, and ( 2 ) that he look to the extraction and sale of the mineral for the return key of this investment. Since Palmer v. Bender, quite naturally the battles in this area of tax law have been fought over whether there was an matter to in the vegetable oil in locate of the proper sort and whether the informant of the return of the taxpayer ‘s capital was the origin and sale of mineral. The major factor seriously in dispute between the parties, in the case at bar, involves the first criterion — an interest in the petroleum in target. The government espouses two theories — either one, it contends, provides the transferors of the allowables the needed interest in the anoint in locate indeed as to entitle them to claim depletion on the amounts received from taxpayer for each barrel of oil produced pursuant to the transferred allowables. One view is based on the physical and geological characteristics of the East Texas Oil Field. The government argues that since the Field is a common consortium or reservoir of oil, when taxpayer was permitted to withdraw a greater quantity of oil made possible through the acquisition of the allowables, it in effect was withdrawing the oil under the transferors ‘ closed wells. From this the government concludes that the economic sake in the vegetable oil in place under the close up wells which the transferors have, is sufficient to entitle them to depletion. In support of this argument the government points out that the Railroad Commission based the come of the “ salt-water homebound allowable ” which could be transferred according to a “ decline bend ” which was designed to approximate the petroleum which could have been produced from the close well, had it remained in operation. On the other hand, taxpayer points out that there is nothing in the record to suggest that the petroleum under the transferors ‘ leases was depleted, but on the contrary the Railroad Commission ‘s Order specifically provided for the resumption of production by the transferors, after the passing of the “ permissible. ” Taxpayer besides points out that it is a common occurrence in the East Texas Oil Field, that within a short-change distance from an highly productive well, no oil is found. furthermore, the invalid wells were scattered over most of the Field and are not limited to one region, as would be required by the politics ‘s hypothesis. All these factors, taxpayer argues, contradict the government ‘s invention that the East Texas Oil Field is a individual big underlying pool of anoint being tapped with equal adeptness by all the wells in the Field. Taxpayer, during oral argument, urged that the transferors did not meet the second requirement of “ an economic pastime. ” This second factor has been interpreted to mean that the owner of the interest must look solely to the extraction of anoint for a render of his capital, and depletion has been denied where the payments were not dependent on production. Helvering v. Elbe Oil Land Development Co., 303 U.S. 372, 58 S.Ct. 621, 82 L.Ed. 904 ( 1938 ). Taxpayer argues that it had to pay the transferors careless of whether or not it produced oil under the “ allowables. ” It cites P.G. Lake, Inc. v. Commissioner, 24 T.C. 1016 ( 1955 ) in support of its contention. Although the Tax Court based its decision on the testimony of an official of the producing company, a learn of the grant shrink before us indicates that the payments to the tranferors were to be based entirely on production. The general plan which the Railroad Commission attempted to carry out by the habit of the “ decay curve ” in determining the sum of the “ allowable ” for each well, seems, at first bloom, to support the government ‘s placement. however, for the “ decline curl ” to carry out its mean consequence, i, that at the termination of the “ allowable ” the petroleum under the transferor ‘s well would be depleted, the close well must remain in operation. Assuming that the Railroad Commission was justified in making such a prediction, it does not follow that the oil under a closed good would be depleted as a result of the transfer of its permissible. furthermore, there is nothing in the record before us which shows that these closed wells were in fact depleted. Nor can we conclude from the tell before us, that the amount of oil below taxpayer ‘s wells was increased as a result of the alleged stream of anoint from the transferors ‘ closed wells. All we know is that the oil which was being extracted came from taxpayer ‘s wells, and since none was produced from the transferors ‘ closed wells, there is a average given that whatever anoint was under their lease when the permissible was transferred would still be there when the allowable expired. even if the transferors ‘ wells did not have american samoa much oil under their leases when the “ allowable ” expired, there is no evidence in the record which shows that taxpayer ‘s production pursuant to the transferred allowable was the cause of the decrease. therefore, under such circumstances, we can not conclude that as a matter of physical and geological reality the transferors had an interest in the anoint in place under the taxpayer ‘s wells. We think that the use of the “ worsen curvature ” can well be explained on the grounds that the Railroad Commission, faced with the trouble of curtailing the loss of bottom-hole pressure as a leave of some wells producing an excessive amount of salt water, had to devise a footing for determining the sum of the allowable that could be transferred. The habit of the “ decline curve ” was a carnival basis for the estimate. true as a resultant role of this conservation standard, which prevented the drop in bottom-hole coerce, taxpayer was able to obtain a greater amount of recoverable petroleum under its leases. But this does not mean that there was an actual addition of vegetable oil under taxpayer ‘s rent. The politics argues that in the event we find that the record before us is insufficient to support the government ‘s contentions, taxpayer however has failed to meet its burden of proof. We think that the facts before us are sufficient to make a prima facie sheath in party favor of taxpayer. It has shown that all the petroleum which was produced came from its well and none came from the transferors ‘ wells. This raises the presumption that the petroleum below its leases was being depleted. The charge is on the government to prove the reverse. We think that the government has not met this burden. We turn now to the government ‘s second base theory in support of its controversy that the transferors have the necessity investment in the oil in place. It argues that the facts in this case come within the rationale of Southwest Exploration Co., above, since the assignors of the allowables transferred a property pastime which was necessity to taxpayer ‘s right to extract the oil in question. In this area of tax law it is unmanageable to single out one recurring divisor which the courts have found to be indicative mood of an pastime in the minerals in rate. The history of economic interest litigation is better described as the floor of ascertaining which of several basic characteristics may be omitted without eliminating the hypothesis of such an interest. A leave authority on depletion, after an exhaustive analysis of the jurisprudence in this area, concluded that Sneed, The Economic Interest — An Expanding Concept, 35 Texas L.Rev. 307, 355 ( 1957 ).

“[i]n determining the existence of an interest in the minerals in place three basic ideas are involved, viz., the legal form or nature of the instrument, the degree of substantial ownership of the deposit possessed by the interest holder, and the extent and nature of his contribution to development and operation of the property. A legal property interest in the minerals, lasting for the productive life of the property, entitling its holder to significant control of the mineral deposits and beneficial enjoyment of income therefrom, and acquired as the consequence of a contribution to its development or operation, is plainly an interest in the minerals in place. Drop one of these characteristics and the solution of the issue is less certain; drop two and serious doubts arise.”

We view our function in this area of tax law as one of weighing these respective factors in each case and determining whether their presence or absence are indicative of or preclude the universe of an interest in the minerals in place. In so doing, we must recognize that the determination of discovery depletion should shape the leave which we reach. In this deference we must emphasize the fact that Congress sought to encourage the discovery and development of minerals. We recognize besides that the Supreme Court decisions reflect a growing liberality in the lotion of these criteria. however, we do not think it proper for us to take the lead and spearhead this apparent swerve. In other words, we should not go beyond the guidelines set forth by the Supreme Court. In this case the government equates the transferors of the “ allowables ” with the upland owners in Southwest exploration who had “ made an indispensable contribution of the manipulation of real property “ to the drill for and the extraction of oil. ( 350 U.S. at 317, 76 S.Ct. at 400 ). At the beginning it should be noted that aside from Southwest Exploration no Supreme Court decision has found a taxpayer possessing the necessity interest in the mineral in place who did not have either a tip or a leasehold interest in the oil-producing property itself. This apparent passing from prior doctrine can best be explained on the grounds that the concede of discovery depletion in that case served the purposes for which the valuation reserve was created. That is, the highland owners in that case contributed real property which was substantive to the discovery, drilling, and extraction of the oil. Without their participation, there would have been no lease, no wells and no production. In exchange for this contribution, the highland owners acquired an pastime which was measured by the producing life of the wells and they could look to the extraction and sale of oil as a source of return for that sake. In other words, “ [ metric ton ] heir income was dependant entirely on output, and the value of their interest decreased with each barrel of vegetable oil produced. ” ( 350 U.S. at 316, 76 S.Ct. at 400 ) not only were they instrumental in the acquisition of the lease, but besides they “ played a vital character at each consecutive stage of the proceedings. ” ( Id. at 315, 76 S.Ct. at 399 ) The Court felt that although the highland owners did not have a legal place sake in the minerals nor did they have control over the mineral deposits, their contribution to growth and operation was sufficiently significant to indicate an investment in the oil in space. however, the Court cautioned that they were not taking a drastic step from prior doctrine when they stated :

“We decide only that where, in the circumstances of this case, a party essential to the drilling for and extraction of oil has made an indispensable contribution of the use of real property adjacent to the oil deposits in return for a share in the net profits from the production of oil, that party has an economic interest which entitles him to depletion on the income thus received.” [Emphasis added. 350 U.S. at 317, 76 S.Ct. at 400]

In the lawsuit at bar, the transferors like the upland owners did not have a legal property interest in the minerals, nor did they have control over the mineral deposits. Thus their entitlement to share in the depletion allowance must be based on their contribution to the development or process of the mineral deposits. It seems fair to say that their contribution was not as significant a contribution as was made by the upland owners in Southwest Exploration Co. Their contribution was personal property preferably than real number property ; it was at best essential for the extraction of only separate of the oil ; it was not implemental in the acquisition of the lease, nor was it all-important to the bore operations. Unlike Southwest Exploration Co., the interest the transferors acquired was not measured by the fat biography of the wells but was to be terminated at the passing of the “ allowables. ” Under these circumstances, to find in the lawsuit at bar, an interest in the minerals in place, would require us to go beyond the guidelines set forth by the Supreme Court in Southwest Exploration Co. furthermore, to do so, we think, would do ferocity to the clear congressional aim in granting discovery depletion. consequently, we hold that the transferors of the “ allowables ” here in interrogate do not have the necessity “ economic interest ” in the oil in place with respect to the petroleum produced under these allowables so as to entitle them to share in depletion allowance. consequently, taxpayer is entitled to take the depletion allowance in question, since the amounts paid by it to these transferors do not constitute royalties and need not be ex-before computing its depletion allowance for 1952.

This is specially true, if at the exhalation of the allowables, the transferors were to reopen the close wells and resume output. In that event, the transferors would be entitled to depletion twice. consequently, judgment is entered for taxpayer with the sum of convalescence to be determined pursuant to Rule 47 ( c ) ( 2 ) of the Rules of this court.

APPENDIX

11. The following is a typical “Assignment of Shut-in Allowable”:

“ assignment of Shut-in Allowable

“This agreement, made as of the First day of November, 1951, between ELM OIL COMPANY et al, hereinafter called `ASSIGNOR’, whose mailing address is P.O. Box 839, Dallas, Texas, and TIDE WATER ASSOCIATED OIL COMPANY, hereinafter called `ASSIGNEE’, with an office in Houston, Texas, WITNESSETH:

“Assignor represents that it has heretofore made application to the Railroad Commission of Texas for the transfer of the oil allowable of the #2 and #3 wells on Assignor’s L.L. Jones lease which is a tract of 15 acres, more or less, out of the Corduva Survey of Rusk County, Texas, and is in the East Texas Oil Field; that the application was made pursuant to an order of the Railroad Commission of Texas, herein called `Commission’, of July 10, 1947, No. 6-10,956, Oil and Gas Docket No. 120; that Assignor now owns and operates the oil and gas lease on which the wells to be shut in are located; that the application, in conformity with the procedure established by the commission, bears the approval of the District Supervisor and the District Engineer of the Commission with respect to (a) the right of Assignor to transfer, for production by other wells in said Field, the amount of oil allowable as stated in the approved application, and (b) the transfer to the Assignee, named herein, of the right to produce all of the allowable applicable to the shut-in wells.

“Assignor, for a valuable consideration, hereby sells, transfers and assigns unto Assignee all of Assignor’s right to produce the oil in the said Field in the amounts to be approved monthly by the Railroad Commission of Texas. Assignor represents and warrants that Assignor has the right to make this assignment and has not sold or assigned or encumbered in any way the rights herein transferred to Assignee. Assignor further represents and warrants that the lease on which the specified shut-in wells are located is in full force and effect and will be maintained by Assignor in full force and effect during the life of this agreement.

“This assignment shall take effect on the First day of November, 1951. All of the oil produced by Assignee under this agreement shall be the property of Assignee.

“This assignment is subject to the orders of, and the approval of said Commission, the approval and designation by the Commission of the wells and lease from which, and the time at which the allowables, the rights to produce which are herein assigned, may be produced by Assignee, and the designation, by the Commission, in its allowable schedules, of the amount of such allowables which Assignee may produce.

“Subject to the other provisions hereof, Assignee agrees to pay to Assignor a sum of money equivalent to Two Dollars and Four Cents ($2.04) for each and every barrel of such transferred allowable which Assignee produces after November 1, 1951; provided, however, that if at any time hereafter during the life of this contract Tide Water Associated Oil Company has in effect in the East Texas Field an open division order posted price in excess of 2.65 per barrel for the regular oil allowables in said Field, then and in that event, and for each and every barrel of such transferred allowable which Assignee produces during the time such price in excess of $2.65 is posted, Assignee agrees to pay to Assignor a sum of money (in addition to said $2.04) equivalent to 84% of the excess of such posted price per barrel (in effect at the time such transferred allowable is produced) over and above $2.65. It is further provided that if at any time hereafter, during the life of this contract, Tide Water Associated Oil Company has in effect in the East Texas Field an open division order posted price less than $2.65 per barrel for the regular oil allowable in said Field, then and in that event, and for each and every barrel of such transferred allowable which Assignee produces during the time such price less than $2.65 is posted, Assignee agrees to pay to Assignor, in lieu of and instead of the $2.04 per barrel first hereinabove provided for, a sum of money equivalent to $2.04 less 84% of the difference between such posted price and $2.65. Accounting is to be made on or before the 25th day of each month for the transferred allowable oil produced hereunder during the preceding calendar month.

“Assignor agrees that if Assignee’s or Assignor’s rights hereunder should come into dispute or litigation Assignee may withhold payment of any sum (to the extent of the amount claimed in such dispute or litigation) payable hereunder, without interest, until final adjudication or other settlement of such dispute or litigation.

“Assignor agrees to make settlement with or payment to all royalty owners and all other parties who have or acquire any interest in the allowable transferred hereunder and agrees to indemnify and save Assignee harmless from any loss, cost, damage or expense suffered or incurred by Assignee by reason of its purchase of or payment for the rights herein conveyed, or by reason of any failure of Assignor to perform any of its obligations arising hereunder.

“In witness whereof, this instrument is executed on the date first above written.”

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