VON BAUMBACH, Collector of Internal Revenue, v. SARGENT LAND CO.; SAME v. SUTTON LAND CO.; SAME v. KEARSARGE LAND CO., 219 F. 31

SANBORN, Circuit Judge (after stating the facts as above). For doing business in a corporate capacity the Tax Corporation Act of August 5, 1909 (36 Stat. 112, § 38), imposes upon every corporation organized for profit having capital stock represented by shares an annual excise tax equivalent to 1 per cent, of its net income above $5,000.

It provides that such net income shall be ascertained by the deduction from “the gross amount of the income of such corporation * * * received within the year from all sources” by it (1) its expenses of operation paid out of income; (2) its losses including a reasonable allowance for the depreciation of its property; (3) certain interest paid by it; (4) taxes paid by it; and (5) dividends on stock of corporations subject to the excise tax.

The basis of the standard or measure by which the amount of the tax is to be determined is “the gross amount of the income of such corporation * * * received within the year from all sources,” not the gross amount received by the corporation from all sources, and from this amount of its income is to be deducted its expenses paid out of its income, not any expenses paid out of its capital or property, and an allowance for depreciation of its property.

That the word “income” in this act is not synonymous with the word “receipts,” and that it does not include receipts from the conversion without gain or profit of any part of the property of the corporation into money, or into any other form, is demonstrated by the fact that this word “income” appears in the clause “the gross amount of the income of such corporation,” and - segregates and designates a specific part, and not all, of the receipts of the corporation as the basis of the measure of the tax, by the fact that only those expenses paid out of income, none of those paid out of capital or property, are to be deducted, by the fact that a deduction for depreciation of property is to be made, by the evident purpose and the whole tenor of the act.

This word “income” is used throughout the statute in contradistinction to “property” or “invested capital,” and it was neither the intention of the Congress nor is it the legal effect of the act to impose any tax on account of the amounts received by a corporation that is not engaged in the business of buying, selling, or trading in property, from the conversion of its property without gain into money or into any other form. These corporations were never engaged in any such business.

And it is not doubtful that the small amounts of money received by them from the sales of the lots and lands that were conveyed to them at their organization in 1906 were not income, but were mere proceeds of parts of their property on account of which they could not be lawfully taxed.

But were the royalties which had been owing to these corporations by the lessees since 1906, and which these Corporations collected and received in 1909, 1910, and 1911, as they fell due, income by the amount of which the taxes upon them must be measured under the tax act, or were they the mere proceeds of the conversion without gain or profit of parts of their property into money and no part of the measure of their lawful tax ? The lands, and hence the property, of the corporations, had no substantial value without the rights to collect the royalties the lessees had covenanted to pay.

The leases had been made by the former owners prior to 1907, and if there was any gain, profit, or income from the making of the leases, that income accrued years before the Tax Act took effect, and the corporations are exempt from any taxation on account of it. The lessors by the leases granted to the lessees the exclusive right to dig, remove, and have all the iron ore in the lands and the right to remove it during terms such as 25 or 50 years, so long in fact that they were in effect a grant of the right to take it without limit of time or quantity.

The lessees had covenanted to pay annually certain fixed amounts such as 25 cents or 30 cents a ton for the ore they extracted and to pay fixed minimum amounts every year whether they extracted ore or not which were contracted to be and were credited on their liability for ore subsequently taken whenever in any year they failed to extract sufficient ore to come to the minimum amounts.

In 1906 and 1907 these corporations took from the lessors the latter’s claims and rights to collect and receive from the lessees the royalties they had covenanted to pay for the ore, and the title to the lands and issued their stock therefor. If there was any gain, profit, or income in this transaction it was made in 1906 and 1907, at least two years before January 1, 1909, when the Tax Act took effect, and the corporations were exempt from taxation on account of that income. Merchants’ Ins. Co. v. McCartney, Fed. Cas. No. 9,443, 17 Fed. Cas. 46.

On January 1, 1909, when the act took effect, and for years before that date, these corporations were the owners of the claims and rights to collect and receive the amounts which the lessees had covenanted by the leases to pay for the ore in the lands and of the lands themselves. These things were their absolute property on January 1, 1909, and none of them was any part of their subsequent income, gain, or profit.

The land was practically worthless; the rights and claims to collect the amounts the lessees had covenanted to pay for the ores were practically all there was of value in their property, and these were worth hundreds of thousands of dollars. If they had sold these claims in 1909 for cash for their actual value, for no more and no less than their actual value, no part of that cash could have been gain, profit, or income. It could not have escaped being a mere different form of their property, of their capital, and the corporations could not have been taxable on account of it.

If prior to 1909 A. had bought promissory notes secured by mortgages worth their face, payable without interest during the years 1909, 1910, and 1911, and had collected them during those years, the moneys thus collected could not have been his gain, profit, or income. It could not have escaped being simply a different form of his property or capital.

If in 1906 the owner of land had sold it for the promissory notes of B. secured by mortgages worth their face, payable without interest 10 per cent, annually during ten years, and had contracted to convey the land upon the payment of the notes, and A. had purchased the notes prior to 1909, and had collected the amounts due on them during the years 1909, 1910, and 1911, the moneys so paid could not have been income. They must have been but a part of A.’s property in another form, for the amount and value of his property would be the same the moment after he collected any of them that it was the moment before.

The only -difference would have been that the moment before it would all have been in notes, and the moment after part of it would have been in notes and part of it in cash.

So when the parts of the rights and claims of these corporations which the lessees covenanted by the leases to pay for the ores came due and were received by the corporations in 1909, 1910, and 1911, the value of their property was neither increased nor diminished.- The amount and the value of their unpaid claims was diminished by the amount that the value of their cash was increased by the payments, and the moneys received became a part of their property.

In the application of this Tax Act to the numberless and varied situations which different cases present, the actual facts of each case and their real consequences must be considered and given legitimate effect, regardless of misleading names and forms. The fact that the amounts which the lessees covenanted to pay are called rents or royalties in the leases or elsewhere must not be permitted to blind us to the true nature of the transactions which those leases evidenced. They were negotiated, and all but one of them was executed, by the individual owners of the lands prior to 1907.

The land, including the right to the ore in it, was worth hundreds of thousands of dollars. Without the right to the ore it was worth'practically nothing.

By the leases the owners of the land granted to the lessees the absolute and exclusive fight to take out and have all the ore in the land, and to remove it at any time within 25 to 50 years, a time so long that it was ample to enable them to remove all of it, and'was equivalent to an unlimited time, and the lessees agreed to pay the yearly fixed amounts per ton for all the ore they should take, and to pay the minimum amounts annually whether, the ore was taken or not.

The result was that the lessors granted a part of the corpus of the property,, that by the grant"the lessees were made the owners of the ore and the lessors the owners of the claims and of the rights to collect the amounts the lessees covenanted to pay for the ores, and the transactions were in reality sales of the ore for covenants to pay the purchase price thereof.

A mining lease, whereby the lessee is granted the absolute and exclusive right to dig for, remove, and have the mineral in the land during terms sufficiently long to enable him to remove it, is in reality a sale of the ore, and the royalties reserved are in fact the purchase price of it. Stoughton’s Appeal, 88 Pa. 198, 201, 202; Scranton v. Phillips, 94 Pa. 15, 22; Coltness Iron Co. v. Black, 6 Appeal Cases, 315, 335 (where Lord Blackburn says: “It was said by Lord Cairns in Gowan v. Christie, 3 Ex.

D. 23, that a lease of mines, ‘is not in reality a lease at all in the sense in which we speak of an agricultural lease. There is no fruit; that is to say, there is no sowing and reaping, in the ordinary sense of the term and there are no periodical harvests. What we call a mineral lease is really, when properly considered, a sale out and out of a portion of the land.’ I think this is a perfectly accurate statement”); Eley’s Appeal, 103 Pa. 300; Delaware, L. & W. R. R. Co. v. Sanderson, 109 Pa. 583, 1 Atl. 394, 396, 58 Am. Rep. 743; Hope’s Appeal (Pa.) 3 Atl. 23; Caldwell v. Fulton, 31 Pa. 475, 72 Am.

Dec. 760; Harlan v. Lehigh Coal & Navigation Co., 35 Pa. 287, 292; Tiley v. Moyers, 43 Pa. 404, 410; Fairchild v. Fairchild (Pa.) 9 Atl. 255, 257. It is true that there is a decision in apparent conflict with this rational and established rule. State v. Evans, 99 Minn. 220, 223, 225, 227, 108 N. W. 958, 9 Ann. Cas. 520. But that was a decision ex necessitate, and its effect must be limited to its special facts. The Constitution of Minnesota prohibited any sale of any part of the school or swamp lands of the state otherwise than at public sale. A statute of the state had authorized mining leases of these lands.

The state had made leases of many of them, upon the faith of which more than $2,-400,000 had been invested, when one of them was assailed on the ground that the statute was unconstitutional and the lease was void.

Thereupon the court saved the leases and the statute on the grounds that if there was any doubt of the constitutionality of the law it was their duty to uphold it, that the state officers had acted upon the theory that it was valid, that it had been before the Supreme Court four times and they had rendered decisions based upon it without any challenge of its constitutionality and that it was not so clear that it was unconstitutional that it was their duty to strike it down. That decision is not persuasive in the case at bar.

If the purchase price of the ores, called “royalties” in the leases, ever became income, it must have been when the leases were made. But the truth is that the leases merely changed the form of the property of the lessors from the ores to the rights and claims to the purchase price of the ores, which the lessees covenanted to pay under the name of “royalties,” and the receipts by the corporation of the payments of the parts of those claims which fell due in 1909, 1910, and 1911, were but another substitution of the cash received for the parts of the claims paid.

If the sums paid were gain, profit, or income, they might have been withdrawn and expended by the corporations without diminishing the value or amount of their property; but the claims are in fact diminished in amount and value by the amounts paid on them, and the property of the corporations is depreciated by the same amounts, unless the moneys so paid are substituted for the parts of the claims paid and remain the property of the corporations. As the claims are paid, their amounts and their values decrease.

All the ore sold by some of the leases has already been extracted, the claims for its purchase price or royalties have been paid in full, and the claims for them have become worthless. The ore under one of the-leases was exhausted in 1911, and the claim for its purchase price or royalties then became worthless. If the amounts paid under the name of royalties for the ore taken under the exhausted leases had been income, the claims for the royalties would still have been of their original valúe, notwithstanding the payments, and the same is true of claims which have been paid in part only.

These considerations compel the conclusion that these payments on the claims were not income, but parts of the capital of the corporations. There is another view of these cases sustained by the record that leads to the same conclusion.

The proof is plenary and uncontroverted that the sole purpose of the owners of the claims for the royalties and purchase price of the ores and of the lands in organizing the corporations and making them the owners thereof was to collect by means of them those claims, convert the property into money, and distribute it among the grantors to the corporations; that this was the sole purpose of the stockholders of the corporations and their directors and officers in receiving the ownership of the property; and that the corporations have confined their operations to so converting into money and distributing the proceeds of this property.

The reason for these acts was that the interests of the owners were undivided, that they were so numerous and of such ages and conditions that a partition of the property in kind or by a conversion into money and a distribution of it had become imperative, and the owners determined to effect it. Any one of these owners had the equitable right to such a partition.

If one or more of them had petitioned the proper court for such relief, and the court had appointed a receiver or master to collect the claims for the purchase price of the ore or royalties, and to convert the property into money and distribute it among the owners according to their respective interests, could any court lawfully have held that the proceeds thus obtained were the gain, profit or income of the equitable owners?

These corporations stood in the same relation to the claimants for the purchase price of the ore, or the royalties and the moneys they collected from them, and to the equitable owners of the property, their stockholders, that such a receiver would have stood. In reality they received and held these claims and the moneys collected from them in trust to distribute them among the equitable owners of the property, and the moneys they have collected were no more the income of the corporations or of their stockholders than is any part of the claims that are not collected or any other part of their property.

Those collections were simply another form of the property of the corporations and of the stockholders substituted for the parts of the claims paid.

The considerations which have now been stated have convinced that there was no error in the decision of the court below that the moneys collected by the corporations in 1909, 1910, and 1911 under the mining leases on the claims for the royalties on or the purchase price of the ore were not either gross or net income within the meaning of the Tax Act, and that corporations that were, when the Corporation Tax Act took effect on January 1, 1909, the owners of claims purchased years earlier for royalties on ores under mining leases made by their grantors, whereby the absolute right to dig and have all the ore in the lands leased, which without the ore were worthless, and to remove it at any time during terms so long as to be equivalent to an unlimited time, was granted to lessees, and they covenanted to pay therefor yearly fixed amounts per ton for the ore extracted, and minimum amounts yearly to be credited on ore subsequently removed in case sufficient to come to the minimum was not extracted in any year, are not taxable on account of the amounts coming due and received by the corporations in partial payment of those claims during the years 1909, 1910, and 1911, where their property was formerly owned and was conveyed to them by their original stockholders, and the sole purpose of the conveyance and of their organization was to enable them to collect these claims, to convert the property conveyed to them into money, and to divide the proceeds among their stockholders, and the corporations have not engaged in mining, trading, or any other business, but have strictly confined their operations to the accomplishment of that purpose.

Stevens v. Hudson’s Bay Co., 101 Law Times Reports, 96, 97, 98, 99; Foley v. Fletcher, 3 H. & N. 769, 774, 778, 783, 787; Secretary of State for India v. Scoble, 89 Law Times Rep. 1, 3; Tiley v. Moyers, 43 Pa. 404, 410: Gibson v. Cooke, 1 Metc. (Mass.) 75. Before assenting to these conclusions, the arguments of counsel for the United States and the following authorities cited by him were read and considered: Stratton’s Independence, Limited, v. Howbert, 231 U. S. 399, 34 Sup. Ct. 136, 58 L.

Ed. 285: But the decision in that case rests on the conceded proposition that a corporation that is engaged in mining its own property is presumed to be using its property or capital and the labor it employs in the business of mining for profit or income, and that the proceeds of that business, less its expenses, must be presumed, in the absence of evidence to the contrary, to contain gain or income derived by the company from the business of mining from which a reasonable allowance for depreciation of the property may be deducted to find the net income which exactly measures its tax.

The extent of that decision was (1) that corporations actively engaged in the business of mining their own property are subject to the corporation tax; (2) that the proceeds of ores mined by a corporation from its own premises include presumptive gain or income from its mining business, and are therefore included in its gross income, within the meaning of the tax Act; and (3) that the allowance to be made for the depreciation of its property by reason of the extraction of the ore so mined is not the exact difference between the proceeds of the mining, less the expenses thereof, because such an allowance excludes the possibility of gain from the mining business the existence of which is presumed. 231 U.

S. pages 418, 421, 34 Sup. Ct. 136, 58 L. Ed. 285.

The decision applies to the corporations that are the lessees and are conducting the business of mining the ores sold through these leases in the cases in hand, but it is inapplicable to the plaintiffs below, because they do not and cannot get the gain or income from the mining which the lessees receive, and they have not been and are not conducting the business of mining, or doing any other business for gain, but have been, were, and are confining their operations to the collection of their claims, arid the conversion of their property into money, and dividing its proceeds among the equitable owners thereof, their stockholders.

Flint v. Stone Tracy Co., 220 U. S. 107, 145, 146, 170, 31 Sup. Ct. 342, 55 L. Ed. 389, Ann. Cas. 1912B, 1312: Iri these cases the Supreme Court held that the rents received by a corporation engaged for profit in the business of owning and leasing taxicabs, or buildings, or ore lands, constituted a part of its gross income within the meaning of the tax act. But the plaintiffs below never have been engaged in any such business. They never negotiated a mining lease.

If there ever was any gain from owning and leasing any of their property, it was made by their grantors more than two years before January 1, 1909, and had become á part of the property, the capital they were organized to and have confined themselves to converting into money and dividing among the equitable owners thereof, the cestuis que trust, and the facts of this case exclude them frpm the operation of the principles on which the Flint Cases rest and from the effect of that decision.

Authorities to the effect that a devise of rents and profits of mineral lands with power to an executor to make leases thereof was intended by the testator to and did carry the royalties under such leases to the devisees. Daly v. Beckett, 24 Beavan’s Rep. 114; Eley’s Appeal, 103 Pa. 300, 305, 307; McClintock v. Dana, 106 Pa. 386; Appeal of Shoemaker et al., 106 Pa. 392; Raynolds v. Hanna (C. C.) 55 Fed. 783, 800, 801.

But these decisions are irrelevant to the construction of the Corporation Tax Act or its application to the facts of this case, because the intent of the testator drawn from the terms of his will and his situation necessarily determined the decision in each case, and' the terms and purpose of each will was too far aside from the terms and object of the Tax Act, and because the testators of these wills contemplated and authorized the business of mining by the executor by means of which he could make long or short leases.

But the plaintiffs below neither mined nor made leases, but confined their operations to the mere collection of claims for royalties or the purchase price of the ores and the conversion of their property into money and its distribution, without gain to themselves, among those for whom they held it in trust before the Corporation Tax Act took effect.

Authorities to the effect that a lessee corporation engaged in the business of mining is not forbidden, by the general law that corporations conducting business for profit may not pay dividends out of capital, from paying dividends out of the net proceeds of their mining business. Lee v. Neuchatel Asphalte Co., 41 Chan. Div. 1, 27; Excelsior Water & Min. Co. v. Pierce, 90 Cal. 131, 140, 27 Pac. 44. But these decisions are inapplicable to the cases in hand for the same reasons as is the Case of Stratton’s Independence.

Authorities to the effect that the proceeds of the operation of mining and selling ore from lands owned or leased by the operating company, less the expenses of operation, are subject to taxes imposed by statute on “net earnings or income,” or on “profits.” Commonwealth v. Ocean Oil Co., 59 Pa. 61, 63, 64; Commonwealth v. Penn Gas Coal Co., 62 Pa. 241, 242; Coltness Iron Co. v. Black, 6 Appeal Cases, 315, 335, 336; People v. Roberts, 156 N. Y. 585, 51 N. E. 293. But these decisions, like that of Stratton’s Independence, apply only to companies actively engaged in the business of mining.

The plaintiffs were not so engaged. They confined their operations strictly to the collection of claims against lessees for the purchase price of or royalties on the ore, and the conversion of their property acquired years before the Tax Act took effect into money and its distribution among their stockholders, the equitable owners of it. They do not fall under the decisions in the cases cited by counsel for the United States, nor under the rules or reasons on which they rest.

They are far within the established principle that the collection of a good claim, or the conversion of property by sale or otherwise into its true value in money, does not transform the proceeds into income, but merely substitutes them for the claim so collected, or the property sold, and leaves them in a different form, a part of the capital or property from which they were derived.

A reading of the opinions of the courts, study and meditation on the terms and meaning of the Tax Act, on the facts of these cases, and the reasons for the propositions of counsel, have convinced that such was the nature of the moneys received by the plaintiffs during the years 1909, 1910, and 1911 from their collections of their claims against the lessees for the purchase price of or the royalties on the ore, that those amounts were not a part of either the gross income or of the net income of the corporations, and that the judgments of the court below were right.

It is interesting to note here, though, for the reasons stated, it is not material to the decision of this case, the ground upon which Lord Blackburn, who delivered the main opinion in the leading case of Coltness Iron Co. v. Black, 6 Appeal Cases 315, 330, 336, placed the decision in that case that the proceeds of an operating mining company were taxable as income under the English Income Tax Act.

He did not place it on the ground that such proceeds were gains or profits, but on the ground that the statute, which imposed a yearly tax “for every 20s. of the annual value thereof, the sum of 7d.,” and provided that “the annual value of all the properties hereinafter described shall be understood to be the full amount for one year, or the average amount for one year (and of the property of mines for five years), of the profits received therefrom within the respective times herein limited,” must be construed in the light of previous English tax legislation and practice to mean that the proceeds of the mines were the measure of this taxation.

Pages 334, 335.

In order to reach this conclusion he reviewed the history of English taxation from the times of Elizabeth, and showed that, long before any income tax was imposed, coal mines were rated for taxation on the basis of their production (pages 330, 331), that this practice had been followed under the earlier statutes, whether they imposed property or income taxes, and from this long practice and this earlier legislation he drew the conclusion that such must have been the intention of the legislators who enacted the income tax statute, and overruled an earlier decision to the contrary (pages 335, 336; Knowles v.

McAdam, 3 Ex. D. 23). Repeated readings of this opinion and the other opinions in that case lead to the conclusion that they are not even persuasive of the true

interpretation and application of our Corporation Tax Act, because they are dominated by a long practice in taxation and a course of legislation that have never existed in this country. There are still other reasons than those which have been stated why the judgments below should not be reversed.

If there were error in the conclusion that the receipts of the companies from their collections of the amounts of their claims against the lessees which came due in 1909, 1910, and 1911 for the purchase price of or the royalties on the ore were not included in their gross income, if they were a part of that gross income, then the companies would have been entitled to “a reasonable allowance for depreciation of property” by the reduction of the values of their claims by these payments. Stratton’s Independence, Limited, v. Howbert, 231 U. S. 399, 418, 34 Sup. Ct. 136, 58 L. Ed. 285.

And as the payments on these claims unavoidably reduced and depreciated their value, as has been shown, by the amounts paid, there would have been no net income from them on account of which an excise tax could have been lawfully exacted. United States v. Nipissing Mines Co. (D. C.) 202 Fed. 803, 805; Stevens v. Hudson’s Bay Co., 101 L. T. Rep. 96, 97, 98. Again, this excise tax was imposed on corporations for doing business in a corporate capacity. It is imposed on corporations “doing business,” and on those only.

Corporations that are the owners of property not used in business, that themselves engage in no trading, mining, or other like business for gain, but confine their activities to acts necessary or incidental to the protection of their property and its conversion into money, are not “doing business” within the meaning of the Corporation Tax Act.

These companies were such owners during the years 1909, 1910, and 1911, and, as has been shown, they not only so confined their operations, but in 1909, by an amendment of their articles of incorporation, they disabled themselves from conducting any other operations or doing any business within the true

interpretation of the Tax Act. They were not, therefore, taxable under that act, and for that reason the judgments below are right. McCoach v. Minehill Ry. Co., 228 U. S. 295, 305, 306, 309, 311, 33 Sup. Ct. 419, 57 L. Ed. 842; Zonne v. Minneapolis Syndicate, 220 U. S. 187, 190, 31 Sup. Ct. 361, 55 L. Ed. 428; United States v. Nipissing Mines Co., 206 Fed. 431, 433, 434, 124 C. C. A. 313. It is true that the court below took the opposite view of the last proposition, and the companies sued out no writs of error.

But there was no error in the course of the trial of the cases, nor in the judgment, and a right judgment, which is warranted by the record and the facts, may not be reversed 'on the sole ground that the trial court gave a wrong reason for it. Smiley v. Barker, 83 Fed. 684, 687. 28 C. C. A. 9, 12; Baker v. Kaiser, 126 Fed. 317, 318, 61 C. C. A. 303, 304; Buster v. Wright, 135 Fed. 947, 959, 68 C. C. A. 505, 517. Let the judgments below be affirmed.