Appeal from the United States Board of Tax Appeals.
Before MANTON, SWAN, and AUGUSTUS N. HAND, Circuit Judges.
Prior to March 1, 1913, and until March 11, 1916, the petitioner owned 250 shares, and her mother 1,180 shares of the stock of the Andrews & Hitchcock Iron Company which had, as its capital structure, 4,000 shares of capital stock issued and outstanding. Andrews & Hitchcock Iron Company held a 12 per cent. stock interest in the Mahoning Ore & Steel Company. This latter company controlled, by a lease of 97 years from April, 1895, an iron ore mine -- the Mahoning Mine -- located on the Mesaba Range in Minnesota. It was an operating company, and mined the ore which it distributed only to its stockholders, who were steel manufacturers. The property consisted of 1,000 acres of mineral land, and it was estimated that it contained on October 11, 1916, 82,858,535 tons of ore.
On March 11, 1916, the Youngstown Sheet & Tube Company purchased all the outstanding capital stock of the Andrews & Hitchcock Company, thus acquiring the 12 per cent. stock interest of the ore mined by the Mahoning Company. In the purchase of this stock, it was paid $2,200,000 in cash and in addition it obtained a contract by which all the former stockholders were paid 60 cents per ton for each and every ton of iron ore which it might thereafter become entitled to receive from the Mahoning Company under the contract between it and the Mahoning Company. Payments were made annually, and all the transferred stock in the Mahoning Company was deposited as collateral security. Petitioner thus acquired a 250/4000 interest in this contract for annual payments, and, when her mother died, she acquired, by bequest from her estate, an additional 550/4000 interest in the contract.
Payments were made to the petitioner on account of this contract by reason of her interest therein, and respondent has held this was part capital return and part income as to the sums received in the years in question, 1918, 1919, and 1920. This resulted in the imposition of the tax which is here in dispute. In arriving at this result, the respondent determined that the total consideration received by the stockholders from the sale of their stock to the Youngstown Sheet & Tube Company on March 11, 1922, was $2,200,000 in cash and $1,942,111.46, the fair market value of the contract providing for payments as stated. And, in determining such fair market value, he estimated the total ore reserves in the Mahoning Mine to be 82,858,535 tons, the average annual production to be 1,841,300 tons, and the life of the mine to be 45 years, and the total future receipts from the contract to be $5,965,814.52. This result was reached by computing the present fair value, using the Haskold formula.
The respondent determined that the total of this consideration was more than the cost of the stock sold but less than its March 1, 1913, value, and he decided that no taxable income had been derived from the sale when made. However, with respect to annual payments from the contract, he determined that each payment should be regarded as part income and part capital return. He found the total amount of capital to be recovered was the fair market value of the contract at the time of its acquisition, and he divided each annual payment as between capital and income in the same proportions as the total capital to be recovered bore to the total anticipated receipts included in the gross income of each former stockholder the entire amount received by him during each year, and he allowed as a deduction therefrom the sum which he determined to be a capital return. As to this petitioner's interest, which she acquired from her mother's estate, he determined that the total amount of capital to be allowed was the fair market value of the interest at the time of the decedent's death and permitted capital to be recovered through apportionment of the annual payments as prescribed. He found the return each year to be 32 1/2 per cent. capital return and 67 1/2 per cent. income.
The Revenue Act of 1918, c. 18 (40 Stat. 1057), provides, in section 210, the normal tax upon the net income of every individual in the taxable year; section 211 in addition to the normal income, a surtax; section 212 defines net income as the gross income less deductions defined in sections 213, 214; section 213(a) considers gross income and includes "gains, profits, and income derived from * * * dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; * * * or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever." And section 214(a) considers allowable deductions and provides:
"(8) A reasonable allowance for the exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescence.* * *
"(10) In the case of mines, oil and gas wells, * * * 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. * * *"
"That for the purpose of ascertaining the gain derived or loss sustained from the sale or other disposition of property, real, personal, or mixed, the basis shall be -- (1) In the case of property acquired before March 1, 1913, the fair market price or value of such property as of that date; and (2) In the case of property acquired on or after that date, the cost thereof; * * * (b) When property is exchanged for other property, the property received in exchange shall for the purpose of determining gain or loss be treated as the equivalent of cash to the amount of its fair market value, if any. * * *"
At the time Regulation 45, relative to the Revenue Act of 1918, was effective, and it provided that taxpayers be allowed a deduction in computing net income in cases of natural deposits, a reasonable allowance for depletion of mineral and other depreciations of improvements; that the fair market value of a property was that amount which induces a willing seller to sell and a willing buyer to purchase. Where there has been no sale and the fair market value at the basic date is to be used, such value will be determined by the method which the prospective buyer or seller in the industry would use in arriving at the sale value of the property at the basic date. And article 206 of the Regulation provides the method of determining the fair market value of mineral property.Article 210 provides the computation of deduction for depletion of mineral deposits, and by it (a) Depletion attaches to the annual production "according to the peculiar conditions of each case. * * *" (b) When the value of the property at the basic date has been determined, depletion for the taxable year shall be determined by dividing the value remaining for depletion by the number of units of mineral to which this value is applicable, and by multiplying the unit value for depletion, so determined, by the number of units sold within the taxable year. In the selection of a unit for depletion, preference shall be given to the principal or customary unit or units paid for in the product sold.
The valuation placed on the contract for the stockholder's benefit, giving them 60 cents a ton, in this case, together with cash paid in the sale, showed no gain over March 1, 1913, valuation, and there was no income tax payable in 1916. However, on the theory that there was a gain involved in the future obligations during the period of 45 years, the tax was imposed by determining, in the manner referred to, that each annual payment was part capital and part income. Income is declared and taxes imposed where cash is paid in a sale or where the thing received is capable of easy valuation in cash. Lynch v. Turrish (1918) 247 U.S. 221, 38 S. Ct. 537, 62 L. Ed. 1087; Safe Deposit & Trust Co. v. Miles (D.C. 1921) 273 F. 822.Where the consideration received is found to be the equivalent of cash, it may be valued, and, if a profit is realized, it will be taxed. Marr v. United States (1925) 268 U.S. 536, 45 S. Ct. 575, 69 L. Ed. 1079. Before income can be derived, ...