[242 U.S. 503, 504] Assistant Attorney General Wallace for petitioner.
[242 U.S. 503, 507] Messrs. John R. Van Derlip, Burt F. Lum, and Kenneth Taylor for respondents.
Mr. Justice Day delivered the opinion of the court:
These three cases were argued and submitted together and involve practically the same facts. Suits were brought by the corporations named in the United States district court for the district of Minnesota against the collector of internal revenue, to recover certain taxes, paid under protest, assessed under the Corporation Tax Law of 1909 (36 Stat. at L. 11, 112, chap. 6), for the years 1909, 1910, and 1911. The judgments in the district court were for the respondents (207 Fed. 423), which judgments were affirmed in the circuit court of appeals (134 C. C. A. 649, 219 Fed. 31).
In 1890, John S. Pillsbury, George A. Pillsbury, and Charles A. Pillsbury, doing business together as John S. Pillsbury & Company, were the owners of large tracts of lands in northern Minnesota, which had been acquired for the timber and from which the timber had been cut, being valuable after such severance of the timber for the mineral deposits contained therein. In the year named, the Pillsburys entered into an arrangement with John M. Longyear and Russell M. Bennett, authorizing the latter two to explore the lands for iron deposits. In 1892, Longyear and Bennett having discovered valuable deposits of iron ore, a half interest in something over 10,000 acres of the lands was conveyed to them, the lands thereafter being owned by the Pillsburys, John, George, and Charles, each an undivided sixth, and John M. Longyear and Russell M. Bennett each an undivided fourth. In the year 1901, the Pillsburys having died, these corporations were formed under the laws of Minnesota. In 1906, the ownership of these leased lands was vested in the three corporations named as respondents in the proceedings. As originally organized, the nature of the business was stated to be 'the buying, owning, exploring, and developing, leasing, improving, selling, and dealing in lands, tenements, and hereditaments, and the doing of all things [242 U.S. 503, 512] incidental to the things above specified.' In December, 1909, the articles of incorporation were amended to read as follows: 'The general purpose of the corporation is to unite in one ownership the undivided, fractional interests of its various stockholders in lands, tenements, and hereditaments, and to own such property, and, for the convenience of its stockholders, to receive and distribute to them the proceeds of any disposition of such property, at such times, in such amounts, and in such manner as the board of directors may determine.'
All of the mining leases hereinafter mentioned, with the exception of a contract with the Van Buren Mining Company, were executed before the organization of the corporations. Each of these instruments provided that the owners of the property demised to the lessees, exclusively, all the lands covered by the descriptions, for the purpose of exploring for, mining and removing, the merchantable iron ore which might be found therein for and during the period named, usually fifty years. The lessees were given exclusive right to occupy and control the demised premises and to erect all necessary buildings, structures, and improvements thereon. Right was reserved to the lessors to enter for the purpose of measuring the amount of ore mined and removed and making observations of the operations in the mines. The lessees agreed to pay, in most cases, 25 cents per ton for all ore mined and removed, and to make such payments monthly for ore mined and shipped during the preceding month. The lessees agreed to mine and ship a specified quantity of ore in each year, and, in default of this, to pay the lessors for the minimum amount specified, and take credit therefor and apply such sums upon ore mined and shipped thereafter in excess of such minimum. The lessees were to pay the taxes and to keep the property free from encumbrances and liens. Right was reserved to [242 U.S. 503, 513] terminate the contract upon the failure of the lessees to comply with the terms thereof.
The form of the leases is shown in exhibits 15 and 16, which were not in the printed record, owing to their length, but copies of which, pursuant to stipulation, have been sent to this court. An examination of exhibit 16 shows that the lessees had the right to terminate and surrender the lease by giving the lessors, or those having their estate in the premises, sixty days' written notice, and executing sufficient conveyances releasing all interest and right of the lessees in the premises with any improvements thereon, and surrendering the same in good order and condition, etc., and that thereupon all liability of the lessees to taxes subsequently assessed on the demised premises or for rent thereof thereafter to accrue, or royalty on ores therefrom, except on account of ores removed, should cease and determine; the lessees to be liable for all ores removed from the premises not theretofore paid for, and to pay for the premises rent or royalty for the year in which termination should be made, or the portion thereof which should have expired, at the rate of $12, 500 per annum.
Since their organization the corporations have disposed of certain lands and have also disposed of the stumpage on some timber lands. Certain parcels were rented and leased, and a village was allowed to use part of the land for schoolhouse purposes, as well as another part for a public park.
To insure the proper carrying on of the mining operations, the companies employed another corporation, engaged in engineering and inspection of ore properties, to provide supervision and inspection of the work upon the respondents' properties, for which the inspecting company was paid from month to month, as statements were rendered.
The companies were assessed upon their gross income, [242 U.S. 503, 514] being the entire receipts of the companies from royalties on the leases collected in the years 1909, 1910, and 1911, and some sums received from the sales of lots, lands, and stumpage, from which expenses and taxes were deducted, but no deduction was made upon account of the depletion of the ore in the properties, or on account of such sales.
The brief for the respondents states that these cases present for consideration four questions, which are:
As to the first question, whether these corporations were organized for profit, there can be no difficulty. They certainly do not come within the exceptional character of charitable or eleemosynary organizations excepted from the operation of the act. We need not dwell upon the obvious purpose of these corporations, organized under the provisions of the Minnesota statute concerning companies organized for profit, to pursue gain and to profit because of their operations.
As to the second question: Were the respondents carrying on business, within the meaning of the Corporation Tax Act? This question was dealt with by this court in the first of the Corporation Tax Cases, Flint v. Stone Tracy Co. 220 U.S. 107 , 55 L. ed. 389, 31 Sup. Ct. Rep. 342, Ann. Cas. 1912B, 1312. As the tax was there held to be assessed upon the privilege of doing business in a corporate capacity, it became necessary to inquire what [242 U.S. 503, 515] it was to do business, and this court adopted with approval the definition, judicially approved in other cases, which included within the comprehensive term 'business' 'that which occupies the time, attention, and labor of men for the purpose of a livelihood or profit.'
In that case a number of realty and mining companies were dealt with, and the Park Realty Company, organized to deal in real estate, and engaged at the time in the management and leasing of a certain hotel, was held to be engaged in business. It was also held that the Clark Iron Company, organized under the laws of Minnesota, and owning and leasing ore lands for the purpose of carrying on mining operations, and receiving a royalty depending upon the quantity of ore mined, was engaged in business.
At the same time, and decided with the main corporation tax case, this court held, in the case of Zonne v. Minneapolis Syndicate, 220 U.S. 187 , 55 L. ed. 428, 31 Sup. Ct. Rep. 361, that a corporation which owned a piece of real estate which had been leased for one hundred and thirty years, at an annual rental of $61,000, and which had amended its articles of incorporation so as to limit its purposes to holding the title to the property mentioned, and, for the convenience of its stockholders, to receiving and distributing from time to time the rentals that accrued under the lease and the proceeds of any disposition of the land, was not engaged in doing business within the meaning of the act, by reason of the fact that the corporation had practically gone out of business and had disqualified itself from any activity in respect thereto.
The act next came before this court in the case of McCoach v. Minehill & S. H. R. Co. 228 U.S. 295 , 57 L. ed. 842, 33 Sup. Ct. Rep. 419, in which it was held, distingushing the case of the Park Realty Company, supra, and applying the case of Zonne v. Minneapolis Syndicate, supra, to the facts before the court, that a corporation which had leased all its property to another, and was doing only what was necessary to receive and distribute the income therefrom [242 U.S. 503, 516] among stockholders, was not doing business within the meaning of the act.
In United States v. Emery, B. T. Realty Co. 237 U.S. 28 , 59 L. ed. 825, 35 Sup. Ct. Rep. 499, this court held that a corporation which merely kept up its organization, distributing rent received from a single lessee, was not doing business within the meaning of the act.
It is evident, from what this court has said in dealing with the former cases, that the decision in each instance must depend upon the particular facts before the court. The fair test to be derived from a consideration of all of them is between a corporation which has reduced its activities to the owning and holding of property and the distribution of its avails, and doing only the acts necessary to continue that status, and one which is still active and is maintaining its organization for the purpose of continued efforts in the pursuit of profit and gain, and such activities as are essential to those purposes.
From the facts clearly established in these cases, we think these corporations were doing business, within the meaning of the act. They were organized for the purposes stated, and their activities included something more than the mere holding of property and the distribution of the receipts thereof. As was found by the district court, the evidence shows that these three companies sold, during each of the years named, quantities of real estate, and the same were not small. They sold stumpage from some of the properties which had been burned over, leased certain properties in the village of Hibbing, and granted leases to squatters. One of the companies made explorations and incurred expenses in the matter of test pits. They employed another company to see that the mining operations were properly carried on, and that the lessees lived up to the engagements of their contracts. 'All these things indicate,' said the learned district judge, 'the doing of and engaging in business. It [the corporation] was doing [242 U.S. 503, 517] the business of handling a large property, selling lots, and seeing that the lessees lived up to their contracts. If that is not engaging in business, I do not know what is.' We agree that it certainly was doing business, and, as the Corporation Tax Act requires no particular amount of business in order to bring a company within its terms, we think these activities brought the corporations in question within that line of decisions in this court which have held such corporations were doing business in a corporate capacity within the meaning of the law.
Next, is it true, as contended by the government, that the payments for ore mined, under the contracts covering the mineral lands, are income, within the meaning of the act; or do they represent the conversion of the investment of the corporations from ore into money?
The nature of these mining leases has been the subject of some difference of opinion in the courts. The circuit court of appeals in this case took the view announced in some of the earlier cases, notably in Pennsylvania, that the leases were such in name only, and were in fact conveyances of the ore in place as part of the realty, and that the so- called royalties merely represented payments for so much of the land, and were in no just sense income, but mere conversions of the capital.
These lands are situated in Minnesota, and this character of lease has long been familiar in that state, as a means of securing the development and operation of mining properties. Some years before the passage of the Corporation Tax Act, the supreme court of Minnesota had dealt with the character of such instruments. In the case of State v. Evans, 99 Minn. 220, 108 N. W. 958, 9 Ann. Cas. 520, that court, after a review of the English and American cases, said (page 227):
The same doctrine was held in Boeing v. Owsley, 122 Minn. 190, 142 N. W. 129, and in the late case of State v. Royal Mineral Asso. 132 Minn. 232, 156 N. W. 128, in which the decision of the circuit court of appeals in this case, that such leases were merely conveyances of the ore in place, was brought to the attention of the court, and that conclusion expressly denied, the supreme court of Minnesota saying:
These conclusions of the supreme court of Minnesota are not only made concerning contracts in that state, such as are here involved, but are supported by many authorities. 1 Ordinarily, and as between private parties, there [242 U.S. 503, 519] is no question of the duty of the Federal court to follow these decisions of the Minnesota supreme court, as a rule of real property long established by state decisions. Kuhn v. Fairmont Coal Co. 215 U.S. 349, 360 , 54 S. L. ed. 228, 234, 30 Sup. Ct. Rep. 140. Whether, in considering this Federal statute, we should be constrained to follow the established law of the state, as is contended by the government, we do not need to determine. The decisive question in this case is whether the payments made as so-called royalties amount to income so as to bring such payments within the scope of the Corporation Tax Act of 1909. The prior decisions of this court in Stratton's Independence v. Howbert, 231 U.S. 399 , 58 L. ed. 285, 34 Sup. Ct. Rep. 136, and Stanton v. Baltic Min. Co. 240 U.S. 103 , 60 L. ed. 546, 36 Sup. Ct. Rep. 278, in which the Stratton Case was followed and approved, are decisive of this question. In the Stratton Case, certain questions were certified to this court from the circuit court of appeals for the eighth circuit. The case was tried upon an agreed statement of facts, from which it appeared, 'as to the year 1909, that the company extracted from its lands during the year certain ores bearing gold and other precious metals, which were sold by it for sums largely in excess of the cost of mining, extracting, and marketing the same; that the gross sales amounted to $284,682.85, the cost of extracting, mining, and marketing amounted to $190,939.42, and 'the value of said ores so extracted in the year 1909, when in place in said mine and before extraction thereof, was $93,743.43.' With respect to the operations of the company for the year 1910, the agreed facts were practically the same, except as to dates and amounts. It does not appear that the so-called 'value of the ore in place,' or any other sum, was actually charged off upon the books of the company as depreciation.' The circuit court of appeals certified three questions to this court: 'I. Does 38 of the act of Congress, entitled, 'An Act to Provide Revenue, Equalize Duties, and Encourage the Industries of the United States, and for Other Purposes,' [242 U.S. 503, 520] approved August 5, 1909 (36 Stat. at L. p. 11, chap. 6), apply to mining corporations? II. Are the proceeds of ores mined by a corporation from its own premises income within the meaning of the aforementioned act of Congress? III. If the proceeds from ore sales are to be treated as income, is such a corporation entitled to deduct the value of such ore in place and before it is mined as depreciation within the meaning of 38 of said act of Congress?' This court answered the first and second questions certified in the affirmative, and the third question in the negative. In that case, as here, it was contended that the proceeds of the mining operations resulting from a conversion of the capital represented by real estate into capital represented by cash are in no true sense income. As to this contention, this court said:
It is contended that this case is inapplicable, because the facts disclose that the ores were being mined by a corporation upon its own premises. In our view, this makes no difference in the application of the principles upon which the case was decided. We think that the payments made by the lessees to the corporations now before the court were not in substance the proceeds of an outright sale of a mining property, but, in view of the [242 U.S. 503, 522] terms of these instruments, were in fact rents or royalties to be paid upon entering into the premises and discovering, developing, and removing the mineral resources thereof, and as such must be held now, as then, to come fairly within the term 'income' as intended to be reached and taxed under the terms of the Corporation Tax Act.
In Stanton v. Baltic Min. Co. 240 U.S. 103 , 60 L. ed. 546, 36 Sup. Ct. Rep. 278, the Income Tax Law of 1913 [38 Stat. at L. 166, chap. 16, Comp. Stat. 1913, 6319] was before the court, and it was contended that the clause in that act, limiting the mines to a maximum depreciation allowance of 5 per cent of their annual gross receipts or output of ore deposits, was unconstitutional; or, if that provision was inseparable from the rest of the act, the entire Income Tax Law, as applied to mining companies, was unconstitutional. Replying to the argument advanced by the mining company in that case, this court said that it rested upon the wholly fallacious assumption that, looked at from the point of view of substance, a tax on the product of a mine was necessarily a tax upon the property because of its ownership unless adequate allowance be made for the exhaustion of the ore body resulting from the working of the mine; and, further:
We think it results from the principles announced in these decisions that in such cases as are now under consideration, the corporation being within the meaning of the act organized for profit and doing business, it is subject to the tax upon its income derived from the royalties under these leases.
This brings us to the fourth and last question in the case, as to whether allowance should be made for deprecia- [242 U.S. 503, 523] tion on account of the depletion of the property by removing the ores from the mines in question.
The contention of respondents in this behalf is, that if the court shall find that the moneys received by them under their mining contracts can be deemed gross income, in whole or in part, they are entitled to deduct therefrom, as a reasonable allowance for depreciation, the full amount of the money so received, for the reason that they represent a mere transmutation of capital assets, being, in legal effect, the selling price of their rights in the mineral deposits on or before January 1, 1909, and which, by virtue of the mining contracts then outstanding, had been previously sold for the exact amounts of such receipts.
The statement of facts in the case of Stratton's Independence, supra, as the court states on pages 418 and 419, developed from the certificate, was:
It is true that in the case of Stratton's Independence, supra, the decision upon the question of depreciation was predicated upon the facts stated in the certificate presented to the court, and it was said, at page 422: [242 U.S. 503, 524] 'It would, therefore, be improper for us at this time to enter into the question whether the clause, 'a reasonable allowance for depreciation of property, if any,' calls for an allowance on that account in making up the tax, where no depreciation is charged in practical bookkeeping; or the question whether depreciation, when allowable, may properly be based upon the depletion of the ore supply estimated otherwise than in the mode shown by the agreed statement of facts herein; for to do this would be to attribute a different meaning to the term 'value of the ore in place' than the parties have put upon it, and to instruct the circuit court of appeals respecting a question about which instruction has not been requested and concerning which it does not even appear that any issue is depending before that court.'
It therefore follows that we have the question of depreciation in this case presented under somewhat different circumstances than were outlined in the opinion in the case of Stratton's Independence.
The statute permits deduction of 'all losses sustained within the year . . . including a reasonable allowance for depreciation of property.' What was here meant by 'depreciation of property?' We think Congress used the expression in its ordinary and usual sense as understood by business men. It is common knowledge that business concerns usually keep a depreciation account, in which is charged off the annual losses for wear and tear, and obsolescence of structures, machinery, and personalty in use in the business. We do not think Congress intended to cover the necessary depreciation of a mine by exhaustion of the ores in determining the income to be assessed under the statute by including such exhaustion within the allowance made for depreciation. It would be a strained use of the term 'depreciation' to say that, where ore is taken from a mine in the operation of the property, depreciation, as generally understood in [242 U.S. 503, 525] business circles, follows. True, the value of the mine is lessened from the partial exhaustion of the property, and, owing to its peculiar character, cannot be replaced. But in no accurate sense can such exhaustion of the body of the ore be deemed depreciation. It is equally true that there seems to be a hardship in taxing such receipts as income, without some deduction arising from the fact that the mining property is being continually reduced by the removal of the minerals. But such consideration will not justify this court in attributing to depreciation a sense which we do not believe Congress intended to give to it in the Act of 1909
It may be admitted that a fair argument arises from equitable considerations that, owing to the nature of mining property, an allowance in assessing taxes upon income should be made for the removal of the ore deposits from time to time. Congress recognized this fact in passing the income tax section of the Tariff Act of 1913 ( II. 38 Stat. at L. 166, 167, chap. 16, Comp. Stat. 1913, 6319-6322), when it permitted
and in the Income Tax Law of September 8, 1916 (1915-1916 Stat. 756, 769), a reasonable allowance is made in the cases of mines for depletion thereof, 'not to exceed the market value in the mine of the product thereof which has been mined and sold during the year for which the return and computation are made.' These provisions were not in the Act of 1909, and, as we have said we think that Congress, in that act, used the term 'depreciation' in its ordinary and usual significance. We therefore reach the conclusion that no allowance can be made of the character contended for as an item of depreciation.
No contention is made in the brief for an allowance because of sales of stumpage, lots, and lands belonging to [242 U.S. 503, 526] the companies, as an exhaustion of the capital assets, and evidently the case was brought for the purpose of testing the right of the companies to deduct the royalties agreed to be paid to them upon the removal of the minerals from the lands from the sums for which they were severally assessed.
For the reasons stated, we think the Circuit Court of Appeals and the District Court erred in the judgments rendered, and the same will be reversed and the cases remanded to the District Court for further proceedings, if any are sought, upon claim of right to deduct the value of the lands, lots, and stumpage sold from the assessments made.
Mr. Justice McReynolds took no part in the consideration and decision of these cases.
[ Footnote 1 ] Raynolds v. Hanna, 55 Fed. 783, 800, 801; Tennessee Oil, Gas & Mineral Co. v. Brown, 65 C. C. A. 524, 131 Fed. 696, 700 (opinion by Lurton, J.); Browning v. Boswell, 132 C. C. A. 168, 215 Fed. 826, 834; Backer v. Penn Lubricating Co. 89 C. C. A. 419, 162 Fed. 627; Young v. Ellis, 91 Va. 297, 21 S. E. 480; Gartside v. Outley, 58 Ill. 210, 11 Am. Rep. 59, 10 Mor. Min. Rep. 566; Genet v. Delaware & H. Canal Co. 136 N. Y. 602, 19 L.R.A. 127, 32 N. E. 1078; Lacey v. Newcomb, 95 Iowa, 287, 63 N. W. 704; Austin v. Huntsville Coal & Min. Co. 72 Mo. 535, 37 Am. Rep. 446, 9 Mor. Min. Rep. 115; Brown v. Fowler, 65 Ohio St. 507, 521, 63 N. E. 76; Reg. v. Westbrook, 10 Q. B. 178, 205, 2 New Sess. Cas. 599, 16 L. J. Mag. Cas. N. S. 87, 11 Jur. 515, 22 Eng. Rul. Cas. 623.
[ Footnote 1 ] Comp. St. 1913, 6300.