United States v. Biwabik Mining Company/Opinion of the Court

This case is here upon a writ of certiorari to the United States Circuit Court of Appeals for the Sixth Circuit. It was instituted by the United States in the District Court of the United States for the Northern District of Ohio to recover the sum of $2,653.72, being 1 per cent. upon $265,372.08, which, it was claimed, the mining company had wrongfully omitted from the return of its net income for the year 1910 under the Corporation Tax Act of 1909.

The case was tried upon an agreed statement of facts which, omitting unnecessary details, were epitomized by the District Court as follows:

'In the year 1898 the defendant, by assignment of a lease,     acquired a leasehold estate in certain ore-producing      properties in the state of Minnesota, from which it mined ore      from that date to and including the year 1910. For the year     1910 the defendant made a return to the Collector of Internal Revenue of its gross income, and from this amount      it deducted, 'to cover realization of unearned increment,'      the sum of $265,372.08. The amount of this deduction was     arrived at by multiplying the number of tons of ore mined      during the year by 48 3/4 cents, which was the market value      of the ore in place on the premises on the 1st day of      January, 1909, as estimated by the defendant, this being the      date upon which the returns for taxation were to commence. It     is stipulated that this deduction was made in good faith upon      the claim that it was 'a reasonable allowance for      depreciation' of the property of the defendant for that year.

'In June, 1911, payment was made in accordance with this     return, but the Treasury Department about the month of      October, 1914, after investigating the books and records of      the defendant, made the claim that because the defendant was      not the owner in fee of the premises from which it was mining      ore, but was lessee of the same and was paying a royalty to      the fee owners, it was not entitled to deduct anything for      depletion of the ore body on the premises. Thereupon the     defendant was requested to amend its return for the year 1910      so as to include in its gross income the amount of said      deduction, which it declined to do, and thereupon this suit      was instituted to recover the tax upon the amount of this      deduction, amounting to $2,653.72.

'Some time prior to the making of the return for the year     1910 the defendant estimated the tonnage and the market value      of the ore in place upon the premises upon which it held its      lease, which estimate gave to the ore in place a value of 48      3/4 cents per ton, exclusive of royalty.

'The rights of the defendant in the iron ore mined in the     year 1910 were derived from the assignment to it of a written      lease dated April 4, 1898, by the Biwabik Bessemer Company,      lessor. By the terms of that lease the defendant acquired the     right for the term of fifty years and three months from the 1st day of May, 1898, to explore      for, mine out, and remove the merchantable shipping iron ore      which might be found upon the lands described in the lease      upon the payment of a royalty of 30 cents for each ton mined. The expression 'merchantable ore' is defined as including     'all ores which grade 55 per cent. and above in metallic iron     regardless of other ingredients.'

'The lessee contracted to mine and remove at least 300,000     tons of ore annually, or to pay to the lessor 30 cents per      ton on that amount if it should not be mined, but payments      made in any year in excess of royalty on ore actually mined      could be credited upon the excess which might be mined over      the minimum requirement in subsequent years. Any failure to     keep or perform any of the covenants or conditions of the      lease gave to the lessor the option to take immediate      possession of the premises.

'The lessor in the lease reserved a lien upon any ore mined     and upon all improvements for any unpaid balance of royalty,      and it was also provided in the lease that the lessee should      have the right to terminate the lease on any 1st day of      January during its term by giving ninety days' notice of the      purpose and desire so to do.

'The defendant, at the time it acquired this lease, paid to     the prior lessee the sum of $612,000, in addition to      contracting to pay the 30 cents per ton royalty upon the ore      mined, as has been stated.

'It is stipulated in the agreed statement of facts that the     deposit of ore on the leased premises is of such character      that its quality and quantity were capable of determination      'with extraordinary accuracy' by drilling and shafts, and      that the defendant 'by drilling and by standard recognized      methods' had calculated the tonnage remaining on the land on      January 1, 1909, as 6,874,695 tons, all of which could be      easily removed within the term of the lease.'

Upon these facts the District Court reached the conclusion that the leases in question were not conveyances of ore in place, but were grants of the privilege of entering upon the premises and mining and removing the ore, and, consequently, that the deduction claimed as being one from capital investment could not be allowed. In reaching this conclusion the court cited the opinion of this court in Stratton's Independence, Ltd., v. Howbert, Collector, 231 U.S. 399, 34 Sup. Ct. 136, 58 L. Ed. 285, and the judgment of the Circuit Court of Appeals for the Eighth Circuit (211 Fed. 1023, 127 C. C. A. 667), affirming the judgment of the District Court (207 Fed. 419), which decision of the Circuit Court of Appeals was made after the return of the answer to the questions propounded by that court to this court in the Stratton's Independence Case.

Coming to the question as to what allowance should be made to the mining company by way of deduction from its income in making return the District Judge said:

'The defendant paid $612,000 for the lease under     consideration and in addition assumed the payment of the      royalties stipulated for therein. This may properly and     justly be considered a payment in advance of an increased      royalty on ore to be mined, and that is precisely the      character which the defendant gave to the payment when      dealing with it in its private accounts, in which the      stipulation shows (Exhibit H) that it carried one account,      entitled 'Rate of General Ledger or Capitalized Value .03885      per Ton,' and another account, entitled 'Rate of Increment      Value, January 1, 1909, .44865 per Ton.' These two values      added make the 48 3/4 cents per ton which the defendant      deducted in making its return.

'Thus in its own bookkeeping the defendant gives its private     opinion as to the requisite reimbursement necessary to      maintain its capital investment, and thereby is made      applicable that long-standing rule for the construction of      contracts, viz. 'Show me what men have done under a contract     and I will tell you what it means.' The defendant should not      complain if it be held to that construction of this lease and its investment under it which      it adopted for purposes of its own accounting before the      question of taxation had arisen to call forth ingenuity of      interpretation.

'It results that a decree will be entered allowing instead of     the deduction computed on the basis of 48.75 cents per ton of      ore mined, the sum of .03885 cents per ton, and there being      no question of bad faith in the case  the ends of justice      will be served by the payment of interest at the rate of 6      per cent. per annum from the date when the additional payment     found due should have been made.'

The District Court thereupon entered judgment:

'And the court finds as conclusions of law from said facts     that the defendant was entitled to deduct for and on account      of the 544,353 tons of iron ore mined by it under its lease      in the year 1910, the sum of .03885 cents per ton (which      amount the parties agree hereby is the cost to defendant of      said ore at the time it acquired the property in the year      1898, interest, taxes, surveys, and other carrying charges on      the said ore up to the time of its removal from the said mine      having been charged annually including the year 1910 into      operating expenses), and defendant is not entitled to deduct      the 48.75 cents per ton deducted by it in its return, and      there is due from the defendant to the plaintiff the sum of      $2,442.23, with interest thereon at 6 per cent. from the 30th     day of June, 1911, the date when said sum should have been      paid, and the court assesses the plaintiff's damages herein      at $3,140.70, and judgment is hereby rendered against the      defendant in favor of the plaintiff of the sum of $3,140.70,      with interest from the first day of this term of court.'

The company took the case to the Circuit Court of Appeals upon writ of error, that court reversed the judgment of the District Court, holding that the company was entitled to the deduction of 48.75 cents per ton upon each ton of ore mined, as so much depletion of capital assets. 242 Fed. 9, 154 C. C. A. 601. This conclusion was reached upon a construction of the lease in view of the character of the mining property involved, and largely because of the fact that the quantity of the ore in place could be estimated with substantial accuracy. The court held that the selling price of the ore in any one year so far as it represented the actual value to the mining company of the ore in the ground on January 1, 1909, was not income within the meaning of the Corporation Tax Act of 1909. In the course of its opinion the Circuit Court of Appeals announced the decisive question of law to be:

'So far as the selling price of the ore in 1910 represented     its actual value to the company in the ground on January 1,      1909, was it income or was it the sale price of capital      assets?'

And after dealing with the character of this lease and the property covered by it, said:

'We think that the lessee of such property and under such a     lease is as much entitled as is the owner of the fee to treat      the value of his interest in the ore in the ground at the      beginning of the tax period as his capital-indeed, the      lessee's right to do so, is, in some respects, the stronger      of the two, as hereafter pointed out. Such a lease, as     applied to this situation, is in every substantial way pro      tanto a purchase.'

This view of the character of these instruments and their legal effect differs from that taken by this court in the Sargent Land Company Case, 242 U.S. 503, 37 Sup. Ct. 201, 61 L. Ed. 460, wherein precisely similar iron ore leases were under consideration. In that case this court reached the conclusion that such leases were not conveyances of the ore in place, but were grants of the privilege of entering upon, discovering, and developing and removing the minerals from the land, and that the lessor's income from such operations was obtained by a corporation shown to be carrying on business, and upon principles laid down in previous cases in this court (Stratton's Independence v. Howbert, supra; Stanton v. Baltic Mining Company, 240 U.S. 103, 36 Sup. Ct. 278, 60 L. Ed. 546) that such income was subject to taxation under the Corporation Tax Act of 1909.

In the Sargent Land Company Case it was pointed out that the courts of Minnesota, certainly familiar with the physical characteristics of the ore deposits involved, had in a series of cases held these instruments to be leases, and that the royalties agreed to be paid ere rentals in compensation for the privileges granted the lessee. We held the conclusion of the Minnesota courts to be warranted by reason and authority. 242 U.S. 503, and cases cited in margin, page 518, 37 Sup. Ct. 201, 61 L. Ed. 460.

The Circuit Court of Appeals distinguished the Sargent Land Company Case, and of it said:

'Finally, it is urged that this case is controlled by the     decision of the Supreme Court in the Sargent Land Company      Case. The mining leases involved in that case and in this one     seem to be identical in substance, and it is now said with      great plausibility that the ore in the ground and affected by      such a lease belongs partly to the lessor and partly to the      lessee, and that, if the interest of the lessor is not      capital assets no more is the interest of the lessee, and      that, if the receipts of the former are income so must those      of the latter be. We are convinced that the analogy between     the two cases is superficial and not substantial. In that     case the Supreme Court had to determine whether the royalties      received by the lessor were income or were a depletion of      capital. Many considerations led to the conclusion that they     must be treated as income. The contract was a 'lease,' the     receipts were 'royalties,' and royalties, being rentals, are      inherently income and have been commonly so considered. All     these things seem to have affected the conclusion of the      court, but, after all the dominating thought appears to be      that, when land is devoted to mining it is put to only one of      those productive uses of which it is capable, and that the      product of the use should be called income. The land itself is the chief     thing. After the mining is finished the land remains suitable     for other uses; and the fact-if it is a fact-that the      minerals are the greater part of its value cannot operate to      make the incidental overshadow the principal. These reasons     do not apply at all to the case of the lessee whose existing      interest, at the beginning of the taxing period, over and      above the royalty which he must pay, amounted to $3,000,000;      his entire interest was each year, as far as he went,      consumed and exhausted forever; he did not have remaining the      principal thing, the land, which he could put to some other      use; the receipt in 1910 of his January 1, 1909, interest in      the ore was not the offshoot and income of his property; it      was the transformation and eating up of the very property,      and of the whole of it. We therefore think that applying the     principle of the Sargent Case results in holding that these      receipts were from the sale of capital assets and not from      income.'

We are unable to concur in this view expressed in the opinion of the Circuit Court of Appeals as to the effect of the Sargent Land Company Case. Certainly this court had not in mind the distinction suggested. In the Sargent Land Company Case the Circuit Court of Appeals for the Eighth Circuit found that the land including the ore in it was worth hundreds of thousands of dollars, and without the right to the ore the land was worth practically nothing. 219 Fed. 38, 134 C. C. A. 649. This finding, as well as facts of general knowledge leave little room to suppose that this court made its decision concerning the rights of the lessor influenced by the fact that the land itself was the chief thing, and the ownership of it after the exhaustion of the minerals one of the controlling reasons in reaching the conclusion announced in that case. The lessee takes from the property the ore mined, paying for the privilege so much per ton for each ton removed. He has this right or privilege under the form of lease here involved so long as he sees fit to hold the same without exercising the privilege of cancellation therein contained. He is, as we held in the Sargent Land Company Case, in no legal sense a purchaser of ore in place.

In this case the government took no writ of error as to the partial deduction allowed by the District Court, it follows that the correctness of that ruling is not op n here. The Circuit Court of Appeals erred in making the additional allowance for capital depletion. It follows that the judgment of the Circuit Court of Appeals must be reversed, and that of the District Court affirmed, and it is so ordered.

Reversed.

Mr. Justice CLARKE took no part in the consideration or decision of this case.