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WILLIAM E. HERRING v. COMMISSIONER INTERNAL REVENUE *FN*

decided: December 3, 1934.

WILLIAM E. HERRING
v.
COMMISSIONER OF INTERNAL REVENUE*FN*



CERTIORARI TO THE CIRCUIT COURT OF APPEALS FOR THE FIFTH CIRCUIT.

Hughes, Van Devanter, McReynolds, Brandeis, Sutherland, Butler, Stone, Roberts, Cardozo

Author: Roberts

[ 293 U.S. Page 323]

 MR. JUSTICE ROBERTS delivered the opinion of the Court.

The petitioners are husband and wife and the income which gives rise to this controversy is derived from community property. We are to determine whether, in computing net income under the Revenue Act of 1926, they were entitled to deduct from advance royalty or bonus received upon the execution of oil and gas leases the statutory percentage allowance for depletion, it appearing that there was no production when the leases were made, or at any time within the taxable year.

The petitioners' community estate held a half interest in a partnership whose principal business was cattle raising. The firm owned a tract near Amarillo, Texas. In 1926 it leased portions of this land for the purpose of

[ 293 U.S. Page 324]

     mining and operating for oil and gas. In that year the lessees paid an aggregate of $683,793.75 as advance royalties or bonuses, and were obligated to pay additional royalties of one-eighth of the product or its value as oil and gas were extracted. The leases were for terms of five years and so long thereafter as oil and gas should be produced. When the instruments were executed there was no oil well within three and a half miles of the demised land. The lessors had no right to compel the drilling of wells and none were put down during 1926. In 1930 four were drilled which proved to be commercial gas wells, all made a showing of oil, and one produced from eight to ten barrels a day.

In their tax returns for 1926 the petitioners each claimed a pro rata share of a depletion allowance of $188,043.28, being 27 1/2 per cent. of the bonus payments to the partnership. The Commissioner disallowed the claim. The Board of Tax Appeals sustained his decision. The Circuit Court of Appeals affirmed the Board's action.*fn1 We granted certiorari.*fn2

The pertinent sections of the Revenue Act of 1926 are 214 (a) (9) granting a reasonable deduction for depletion in the case of oil and gas wells, and 204 (c) (2) permitting computation of the allowance at 27 1/2 per centum of the gross income from the property.*fn3

A bonus is not proceeds from the sale of property, but payment in advance for oil and gas to be extracted, and is therefore taxable income.*fn4 As such it is a part of the "gross income from the property" as the phrase is used in ยง 204 (c) (2) to designate the base for the application of the percentage deduction. From these premises the

[ 293 U.S. Page 325]

     petitioners argue that the bonus received does not lose its character as income subject to depletion, merely because it happens that in the year of receipt there was no production of the depletable asset.

The respondent replies that the allowance for depletion is a matter of grace, not of right, and that the act fails to grant any allowance on income such as that here involved. The argument is that in both the relevant sections of the act, the statute says "in the case of . . . oil and gas wells" and this expression necessarily excludes a case where no well exists. In support of this asserted statutory exclusion it is urged that a depletion allowance is essentially and exclusively reimbursement for wastage or exhaustion of assets, and Congress could not have meant to permit an allowance in any year in which there was no extraction ...


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