
    388 F. 2d 337
    SYLVAN C. COLEMAN, TRUSTEE FOR THE STOCKHOLDERS OF UNITED CARBON COMPANY IN DISSOLUTION, AND ASHLAND OIL & REFINING COMPANY v. THE UNITED STATES
    [No. 54-64.
    Decided December 15, 1967]
    
      
      William M. By an, attorney of record, for plaintiffs.
    
      Royal J. Voegeli, Thomas J. Brorby, and Fulbright, Crooker, Freeman, Bates & JaworsM, of counsel.
    
      
      Joseph Kovner, with whom was Assistant Attorney General Mitchell Bogovin, for defendant. Philip B. Miller and Mitchell Samuels on, of counsel.
    Before Cowen, Chief Judge, Laramoee, Dureee, Davis, Collins, Skelton, and Nichols, Judges.
    
   Per Curiam:

This case was referred to Trial Commissioner Mastin G. White with directions to make findings of fact and recommendation for conclusions of law. The commissioner has done so in an opinion and report filed on January 11, 1967. Plaintiffs excepted to the commissioner’s recommended conclusion of law but made no exceptions to his findings of fact. The case has been submitted to the court on oral argument of counsel and the briefs of the parties. Since the court agrees with the commissioner’s findings, opinion, and recommended conclusion of law, with minor modifications, as hereinafter set forth, it hereby adopts the same as modified as the basis for its judgment in this case. Plaintiffs are, therefore, not entitled to recover and the petition is dismissed.

Commissioner White’s opinion, as modified by the court, is as follows:

The plaintiffs are suing for the recoveiy of income taxes paid by a predecessor in interest, the United Carbon Company, Inc. (Maryland), for the calendar year 1953. (For the sake of convenience, the United Carbon Company, Inc. (Maryland), will usually be referred to hereafter in the opinion as “the taxpayer.”)

The facts of this case are similar, in all significant respects, to those that were before the court in CBN Corporation v. United States, 164 Ct. Cl. 540, 328 F. 2d 316 (1964), and in CBN Corporation v. United States, 176 Ct. Cl. 861, 364 F. 2d 393 (1966), cert, denied, 386 U.S. 981 (1967). Accordingly, this case presents to the court again, for a third determination, the same percentage depletion problem which the court passed upon, with diverse results, in the two OBN cases.

The events that led up to the two OBN cases and to the present litigation really began in October 1935. At that time, The Shamrock Oil and Gas Corporation (referred to hereafter in the opinion as “Shamrock”) was engaged in the production of natural gas from lands owned or leased by Shamrock in Moore County, Texas, and in the extraction of the heavier liquid or liquefiable hydrocarbons from the natural gas. The extraction process was performed at a plant which Shamrock operated in Moore County, Texas, and which was known as the McKee Plant. The natural gas that remained after going through the extraction process was known as “residue gas.”

On October 1,1935, Shamrock entered into similar gas sales agreements with two companies that were engaged in the manufacture of carbon black through the burning of natural gas. One of these companies was the Keliance Carbon Company, Inc. (referred to hereafter in the opinion as “Reliance”) , and the other was the Western Carbon Company. Reliance was the predecessor in interest of the taxpayer and, therefore, of the present plaintiffs. The Western Carbon Company was the predecessor in interest of the CBN Corporation.

The term of the October 1, 1935 gas sales agreement between Shamrock and Reliance was for the entire life of Shamrock’s natural gas reserves in Moore County, Texas. Under the agreement, Reliance agreed to construct, in the vicinity of Shamrock’s McKee Plant, a plant for the manufacture of carbon black that would have a capacity to handle a minimum of 30,000,000 cubic feet of natural gas per day. The agreement also provided that Shamrock would sell to Reliance, and that the latter would purchase from Shamrock, a daily minimum of 30,000,000 cubic feet of residue gas (i.e., natural gas from which the liquid or liquefiable hydrocarbons had been removed by Shamrock).

It was the understanding between Shamrock and Reliance that the gas delivered to Reliance under the October 1,1935 agreement would be burned by Reliance in the manufacture of carbon black, and Reliance was to pay for the gas by delivering to Shamrock 30 percent of the carbon black manufactured at Reliance’s plant. However, the October 1,1935 agreement contained a provision stating that Reliance had the right, at any time, to cease burning in the manufacture of carbon black all or any part of the residue gas purchased from Shamrock and to resell such gas, in which event Shamrock was to receive from Reliance a minimum of 2 cents per Mcf on the gas thus resold, plus 50 percent of any amount by which the resale price exceeded 2 cents per Mcf.

The gas sales agreement which Shamrock entered into on October 1, 1935 with the Western Carbon Company (the CBN Corporation’s predecessor in interest) was virtually identical with the gas sales agreement of the same date between Shamrock and Reliance (predecessor in interest of the taxpayer and of the present plaintiffs), as previously summarized in this opinion.

In connection with the gas sales agreements of October 1,1935 between Shamrock and Reliance, and between Shamrock and the Western Carbon Company, the three companies—Shamrock, Reliance, and the Western Carbon Company—entered into a subsidiary agreement that was also dated October 1, 1935. In this subsidiary agreement, Shamrock granted to Reliance and to the Western Carbon Company “the first right, in priority to all other uses or dispositions of its natural gas made by * * * [Shamrock] in twelve thousand (12,000) acres of gas territory owned or controlled by * * * [Shamrock] and located in Moore County, Texas.” The subsidiary agreement further provided (among other things) that “All rights and obligations hereunder shall extend to and be binding upon the parties hereto, their successors and assigns.”

Subsequent to the making on October 1,1935 of the agreements previously mentioned, Reliance and the Western Carbon Company constructed carbon black plants in Moore County, Texas, and in the general vicinity of Shamrock’s McKee Plant. Each carbon black plant had a capacity sufficient to handle a minimum of 30,000,000 cubic feet of natural gas per day. Reliance’s plant was constructed at a cost of approximately $890,000.

By means of an agreement dated November 19, 1946 between Shamrock and the taxpayer — which had succeeded in the meantime to the rights of Reliance under the gas sales agreement of October 1,1985 between Shamrock and Reliance and under the tripartite agreement of the same date involving Shamrock, Reliance, and the Western Carbon Company— Shamrock agreed to “increase the acreage reserves from which the Buyer [the taxpayer] has the prior right to purchase and receive gas under the Gas Sales Agreement dated October 1,1935, by an additional amount of 2,170 acres * * In addition, the agreement of November 19, 1946 between Shamrock and the taxpayer amended the gas sales agreement of October 1,1935 so as to provide that the taxpayer would pay a fixed price per Mcf for the gas delivered by Shamrock after January 1, 1946 and burned by the taxpayer in the manufacture of carbon black (the price was to be 2.435 cents per Mcf as of January 1,1946, and was to increase gradually to 5.5 cents per Mcf as of January 1,1958), and by providing that the taxpayer would pay Shamrock a minimum of 3 cents per Mcf, instead of 2 cents, on any gas which the taxpayer resold instead of burning it in the manufacture of carbon black.

An agreement similar to the one summarized in the preceding paragraph was entered into on November 11, 1946 between Shamrock and the CBN Corporation, which had succeeded to the rights of the Western Carbon. Company under that company’s agreement of October 1, 1935 with Shamrock, and under the tripartite agreement of the same date involving Shamrock, Reliance, and the Western Carbon Company.

Further amendatory agreements were later entered into between Shamrock and the taxpayer. Under the agreements between these two companies, as the agreements existed in the fall of 1952 pursuant to the several amendments, the taxpayer had the prior right to purchase from Shamrock 8,170/ 62,625ths of the residue gas resulting from the recovery of liquid or liquefiable hydrocarbons in two plants that were then being operated by Shamrock in Moore County, Texas (the second plant was known as the Sunray Plant), and such fractional part of the residue gas was declared to be tlie “dedicated reserves” of tlie taxpayer (although the taxpayer was not obligated to purchase more than 28,000,000 cubic feet of residue gas per day, if more than that amount was available under the formula and the taxpayer did not wish to purchase the extra quantity); and the taxpayer had the right, at any time, to cease burning in the manufacture of carbon black, and to resell, 6,000/62,625ths of the residue gas resulting from Shamrock’s processing operations in Moore County, Texas.

In the fall of 1952, the taxpayer gave notice to Shamrock that it intended to shut down its carbon black plant; that it wished to be relieved of the necessity of purchasing the volumes of residue gas which it was required to purchase under the gas sales agreement of October 1,1935, as amended, between the parties but which it did not have the right to resell; and that it desired to effect a resale of the volumes of residue gas that it was authorized to resell under the terms and provisions of the gas sales agreement of October 1,1935, as amended.

Thereafter, on October 15, 1952, Shamrock negotiated a contract which was to be effective on September 1, 1953 and which provided for the sale of Shamrock’s residue gas to the Northern Natural Gas Company. The price which Shamrock was to receive from the Northern Natural Gas Company was much more favorable (it was to begin at 10.5 cents per Mcf as of September 1, 1953, and was to increase to 11.5 cents as of January 1, 1958 and to 12.5 cents as of January 1, 1963) than the price which Shamrock had been receiving from the taxpayer under the gas sales agreement of October 1,1935, as amended.

On November 19, 1952, Shamrock and the taxpayer entered into an agreement that was to supersede and terminate the prior agreements between the parties. The new agreement was originally scheduled to be effective on September 1,1953, but the effective date was later advanced to January 1, 1953. The new agreement, after January 1, 1953, was wholly to control the rights, duties, and obligations of the parties. The new agreement no longer continued in existence the prior arrangement between the parties, whereby Shamrock was obligated to sell to the taxpayer, and the latter was obligated to purchase, residue gas resulting from the processing operations in Shamrock’s plants located in Moore County, Texas. Under the new agreement, Shamrock had the right to sell to other persons, on its own initiative, all the residue gas resulting from the processing operations in its Moore County, Texas, plants. However, Shamrock agreed to pay the taxpayer 6 cents per Mcf on 6,000/62,625ths of the residue gas remaining after the removal of the liquid or liquefiable hydrocarbons in Shamrock’s Moore County, Texas, plants.

A new agreement, similar to the one summarized in the preceding paragraph, was also entered into between Shamrock and the CBN Corporation on November 19, 1952 and became effective on January 1, 1958.

Pursuant to the new agreement of November 19, 1952 between Shamrock and the taxpayer, payments in the total amount of $207,948 from Shamrock accrued to the taxpayer during the calendar year 1958.

In its income tax return for 1953, the taxpayer reported as ordinary income, and did not claim any deduction for percentage depletion with respect to, the $207,948 received from Shamrock in 1953, as indicated in the preceding paragraph. Subsequently, however, a timely claim for refund was filed by the taxpayer, on the ground that it was entitled to a deduction in the amount of $57,185.76 for percentage depletion, under Sections 23 (m) and 114(b) (3) of the Internal Bevenue Code of 1939, with respect to the payments received from Shamrock in 1953 under the agreement of November 19, 1952. The refund claim was subsequently amended so as to assert, in the alternative, that if the payments which Shamrock made to the taxpayer in 1953 under the agreement of November 19,1952 were not subject to percentage depletion, such payments should be treated as gross income from the sale of a capital asset or property used in the trade or business and held for more than 6 months, and, therefore, should receive long-term capital gain treatment under subsections (a) and (j) of Section 117 of the 1939 Code.

The taxpayer’s refund claim, as amended, was disallowed by the Internal Bevenue Service on March 24,1961.

On February 19, 1963, the taxpayer and two other corporations were merged into the United Carbon Company. The next day, a plan for the complete liquidation of the United Carbon Company was adopted by its stockholders. Pursuant to such plan, substantially all the assets of the United Carbon Company that could legally be transferred were sold on February 28,1963 to the Ashland Oil & Refining Company and others. In connection with the sale of assets to the Ashland Oil & Refining Company, the United Carbon Company agreed to transfer to Ashland any proceeds that might be received on the taxpayer’s income tax claim against the United States for 1953.

The United Carbon Company was dissolved on December 31, 1963. Sylvan C. Coleman was subsequently appointed to serve as trustee for the stockholders of the dissolved corporation, with the right to prosecute the income tax claim for 1953 previously asserted by the taxpayer against the United States.

Sylvan C. Coleman, as trustee, and the Ashland Oil & Refining Company filed the present suit on February 27, 1964.

In the first CBN case (164 Ct. Cl. 540, 328 F. 2d 316), this court was called upon to decide whether the CBN Corporation, in connection with the amounts which it received from Shamrock during 1953 under the agreement of November 19, 1952 between Shamrock and the CBN Corporation, was entitled to take the deduction for percentage depletion authorized by Sections 23 (m) and 114(b) (3) of the 1939 Code. This turned upon the ultimate question of whether the CBN Corporation, under its agreement of November 19, 1952 with Shamrock, had an economic interest in the gas in place. Commissioner v. Southwest Exploration Co., 350 U.S. 308, 316 (1956). A divided court answered this question in the affirmative. The court said (164 Ct. Cl. at page 549, 328 F. 2d at page 321) that although under the earlier agreements with Shamrock the CBN Corporation “was nothing more than a purchaser with certain priority rights of purchase,” the CBN Corporation’s position was changed by the agreement of November 19, 1952, since the payments received by the CBN Corporation under that agreement were “equivalent to royalty payments on its designated percentage of all gas produced, used or sold from the acreage designated in tbe new contract,” and the CBN Corporation under the new contract “was in the position of any holder of royalty interest in the proceeds of oil or gas production.” Accordingly, the court held that the CBN Corporation had an economic interest in the gas in place under the agreement of November 19, 1952 between Shamrock and the CBN Corporation, and that the CBN Corporation was entitled to take a deduction for percentage depletion with respect to the amounts received from Shamrock during 1953 under that agreement.

The second CBN case (176 Ct. Cl. 861, 364 F. 2d 393) involved the question of the CBN Corporation’s entitlement to deductions for percentage depletion on amounts received from Shamrock during 1955 and 1956 under the agreement of November 19,1952 between Shamrock and the CBN Corporation. In the meantime, the Internal Bevenue Code of 1939 had been superseded by the Internal Bevenue Code of 1954, but the provisions of the 1954 Code dealing with the allowance of a deduction for depletion with respect to oil and gas wells (Sections 611(a) and 613(a) and (b)(1)) were basically the same as the provisions of the 1939 Code covering the same subject. In the second OBN case, the court again divided, but this time the majority held that the CBN Corporation, under the November 19,1952 agreement between Shamrock and the CBN Corporation, did not have an economic interest in the gas in place, and, therefore, that the CBN Corporation was not entitled to take a deduction for percentage depletion with respect to the amounts which it received in 1955 and 1956 from Shamrock under the November 19, 1952 agreement. The court noted (176 Ct. Cl. at page 871, 364 F. 2d at page 399) that the November 19, 1952 agreement “did not give CBN a leasehold or fee in the land,” and “Further, plaintiff’s participation was not essential to the extraction of the gas,” since “Shamrock could bring up and process the gas at will, without plaintiff’s leave.”

In the present case, with respect to the matter of entitlement to a deduction for percentage depletion, the situation of the taxpayer (predecessor of the plaintiffs) was precisely the same as that of the CBN Corporation in each of the two cases previously mentioned. This case involves amounts which, the taxpayer received in 1958 from Shamrock under an agreement which was dated November 19,1952 and which was virtually identical with the agreement of the same date between Shamrock and the CBN Corporation, discussed by the court in the two CBN cases.

If, as the court held in its latest expression of opinion concerning the tax consequences incident to the agreement of November 19, 1952 between the CBN Corporation and Shamrock, the CBN Corporation did not have an economic interest in the gas in place, and the amounts received from Shamrock under that agreement were not subject to percentage depletion, it necessarily follows that the taxpayer similarly had no economic interest in the gas in place under the November 19, 1952 agreement between the taxpayer and Shamrock, and, accordingly, the taxpayer was not entitled to take a deduction for percentage depletion with respect to the amounts which it received from Shamrock in 1958 under such agreement.

However, the plaintiffs make the alternative contention that if the payments which Shamrock made to the taxpayer, their predecessor, in 1953 under the agreement of November 19, 1952 were not subject to percentage depletion, such payments should have received long-term capital gain treatment under Section 117(a) (4) of the 1939 Code as proceeds derived from the sale or exchange of a capital asset held for more than 6 months, instead of being taxed as ordinary income.

In connection with the plaintiffs’ alternative contention, the primary question requiring consideration is whether the taxpayer’s contractual rights under the gas sales agreement of October 1, 1935, as amended, between the taxpayer and Shamrock, which the taxpayer disposed of in the transaction of November 19, 1952 between the taxpayer and Shamrock, constituted “a capital asset.” If the primary question is answered in the affirmative, it will then be necessary to consider the further question of whether the transaction of November 19,1952 between the taxpayer and Shamrock involved a “sale or exchange” of the taxpayer’s contractual rights under the gas sales agreement of October 1,1935, as amended.

The circumstances under which contractual rights constitute a capital asset for capital gain purposes were thoroughly reviewed in the case of Commissioner v. Ferrer, 304 F. 2d 125 (2nd Cir. 1962). After analyzing the cases in which proceeds from dispositions of contractual rights had been held to merit capital gain treatment, the court said (at page 130):

One common characteristic of the group held to come within the capital gain provision is that the taxpayer had either what might be called an “estate” in * * *, or an “encumbrance” on * * * , or an option to acquire an interest in * * *, property which, if itself held, would be a capital asset. In all these cases the taxpayer had something more than an opportunity, afforded by contract, to obtain periodic receipts of income * * *.

In our case, the contractual rights which the taxpayer disposed of in the transaction of November 19,1952 were, first, the right to purchase residue gas from Shamrock on a priority basis under the gas sales agreement of October 1, 1935, as amended, and, second, the right to bum the entire quantity of purchased gas in the manufacture of carbon black, or to use a portion of such gas for the manufacture of carbon black and resell another portion to third persons if this seemed advantageous to the taxpayer. In other words, what the taxpayer had was “a naked contract right” to purchase gas and thereafter to process or resell the gas, thereby obtaining periodic receipts of ordinary income. Cf. Commissioner v. Pittston Company, 252 F. 2d 344, 348 (2nd Cir. 1958), cert. den. 357 U.S. 919 (1958).

Even in the first CBN case, where a majority of the court held that the CBN Corporation had an economic interest in the gas in place under the new agreement of November 19, 1952 between Shamrock and the CBN Corporation, the court said that under the previous gas sales agreement of October 1, 1935, as amended, between those parties, the CBN Corporation “was nothing more than a purchaser with certain priority rights of purchase” (164 Ct. Cl. at page 549, 328 F. 2d at page 321). The contractual rights of the present taxpayer under the gas sales agreement of October 1,1935, as amended, between Shamrock and the taxpayer were exactly the same, in all substantial respects, as the rights of the CBN Corporation under the similar gas sales agreement of October 1,1935, as amended, to which the CBN Corporation was a party. Therefore, under the pronouncements by the court in both the first CBN case and the second CBN case, the taxpayer did not have any interest in the gas itself, prior to delivery by Shamrock, under the gas sales agreement of October 1, 1935, as amended.

Accordingly, since the gas sales agreement of October 1, 1935, as amended, between the taxpayer and Shamrock merely conferred on the taxpayer “a naked contract right” to purchase gas and use it or resell it as a means of obtaining periodic receipts of ordinary income, and did not vest in the taxpayer an interest in property, the disposition of such right in the transaction of November 19,1952 between Shamrock and the taxpayer did not involve the disposition by the taxpayer of a capital asset.

The conclusion stated in the preceding paragraph makes it unnecessary to consider whether the transaction of November 19,1952 amounted to a “sale or exchange.”

For the reasons previously outlined, it appears that the plaintiffs are not entitled to recover either under their principal theory or under their alternative theory, and that the petition should be dismissed.

Laramore, Judge,

concurring:

In the original OBN case I concurred in the majority opinion. The argument in the second OBN case convinced me that I was in error in the first concurrence. However, I was of the opinion that collateral estoppel prevented the defendant from prevailing. Since no such, question is present in this case,

I concur in the majority opinion.

Skelton, Judge,

dissenting:

I respectfully dissent from the opinion of the majority in this case. The identical facts involved here have been before this court in two other cases in the past, namely, CBN Corp. v. United States, 164 Ct. Cl. 540, 328 F. 2d 316 (1964) and CBN Corp. v. United States, 176 Ct. Cl. 861, 364 F. 2d 393 (1966), cert. denied, 386 U.S. 981 (1967). In the first CBN case, this court held in a well-reasoned opinion that the taxpayer had an economic interest in the gas in place by reason of the agreement of November 19, 1952, between Shamrock Oil and Gas Corporation, hereinafter called Shamrock, and the taxpayer, and, accordingly, the taxpayer was entitled to take a deduction for percentage depletion with respect to the amounts received from Shamrock from the production and sale of gas under the agreement during the taxable year in question. I think that opinion was correct for all of the reasons stated in the opinion, and I adopt such reasons along with the discussion in the following paragraphs as the basis for my dissent in this case.

In the second CBN case, this court reversed its position and held that the taxpayer did not have an economic interest in the gas in place and was not entitled to the depletion allowance. The opinion of the commissioner in the instant case, which is adopted by this court as a per ev/riam opinion, is based entirely on the assumption that the second CBN opinion is correct as to the depletion aspect of the case for all of the reasons stated in that opinion. Therefore, the second CBN opinion is, for all practical purposes, the opinion of this court on the depletion allowance question in the case at bar, as no additional reasons are given in its fer curiam opinion for denying the taxpayer the depletion allowance.

In my opinion, the second CBN decision was wrong for a number of reasons. The court fell into error in holding that the 1952 agreement did not change the status of the parties because it merely rearranged their respective interests. The facts indicate that the contrary is true. The 1952 contract completely terminates the old agreement and creates an entirely new and different relationship between the parties. In this regard, paragraph 1 of the 1952 agreement specifically provides :

1. Effective September 1, 1953, the aforesaid agreements and contracts (i.e., those of 1935 as amended) * * * shall be terminated and be and become of no further force and effect, except as to final accounting * * * prior to September 1, 1953, and thereafter this contract and the provisions hereof shall fully control the rights, duties and obligations of the parties hereto * * *. [Emphasis supplied.]

The court also erred in holding that the 1952 agreement remained basically one of sale (with the taxpayer having only the right to purchase the gas). The opposite is shown by the contract itself. Under the 1952 agreement, the taxpayer had no right to purchase, could not purchase, and did not purchase a single cubic foot of gas from Shamrock. It released all rights of purchase it had under the 1935 contracts to Shamrock. In return, Shamrock agreed to pay the taxpayer six cents per one thousand cubic feet on 6,000/62,625 of the volumes of residue gas it produced and sold from the lands specifically described in Schedule A attached to the 1952 agreement, during the life of its gas leases on such property. This payment was to be made to the taxpayer whether the gas was produced and sold at the well or wells as raw gas or processed through Shamrock’s plant. Paragraph 5 of the agreement provides that Shamrock warrants the title to all gas it may produce and sell and agrees to indemnify the taxpayer with respect to the gas so produced and sold.

This agreement shows clearly it was not a purchase and sale agreement of produced gas as between Shamrock and the taxpayer. The taxpayer had no right to buy any gas produced by Shamrock from its wells and Shamrock had no obligation to sell any of such gas to the taxpayer. This is a complete reversal of the 1935 contract, and establishes an entirely new relationship between the parties.

The court held that the new contract did not give the taxpayer a leasehold or fee in the land. While I do not think this is necessary in order for the taxpayer to have an economic interest in the gas in place, I am of the opinion that the 1952 agreement amounted to an assignment of a portion of the mineral interest of Shamrock. It at least transferred an equitable title to the taxpayer of the interest assigned to it. Shamrock could not sell the gas nor the % working interest which it acquired from the owner of the land by its leases without accounting to the taxpayer for its share of the mineral interest. In other words, Shamrock’s title to the % mineral interest in the lands was clouded to the extent of the assignment to the taxpayer of an interest in 6,000/62,625 of the % interest of Shamrock in the volumes of residue gas in and under the land covered by its leases.

The basic question here is whether the taxpayer had an economic interest in the gas in place. The Supreme Court said in Palmer v. Bender, 287 U.S. 551, 556 (1933), that:

* *• * The allowance to the taxpayer is not restricted by the words of the statute to cases of any particular class or to ‘any special form of legal interest in the oil well. * * *

The court in that case laid down the test or requirement as follows:

* * * The language of the statute is broad enough to provide, at least, for every case in which the taxpayer has acquired, by investment, any interest in the oil in place, and secures, by any form of legal relationship, income derived from the extraction of the oil, to which he must look for the return of his capital. Id. at 557.

These requirements were again approved by the Supreme Court in Commissioner v. Southwest Exploration Co., 350 U.S. 308 (1956).

In my opinion, the taxpayer has met all of these requirements in this case. Whether it owned the leasehold or royalty is beside the point. As stated in Burton-Sutton Oil Co. v. Commissioner, 328 U.S. 25, 32 (1946):

* * * We do not agree * * * that ownership of a royalty or other economic interest in addition to the right to net profits is essential to make the possessor of a right to a share of the net profit the owner of an economic interest in the oil in place.
* * * WThether the instrument creating the rights is a lease, a sublease or an assignment has not been deemed significant from the federal tax viewpoint in determining whether or not the taxpayer had an economic interest in the oil in place.
* * * It is not material whether the payment * * * is in oil or in cash which is the proceeds of the oil, Helvering v. Twin Bell Syndicate, 293 U.S. 312, 321, nor that some of the payments were in the form of a bonus for the contract. Id. at 33.
* * * Depletion depends only upon production. It is the lessor’s, lessee’s or transferee’s “possibility of profit” from the use of his rights over production, “dependent solely upon the extraction and sale of the oil” which marks an economic interest in the oil. Id., at 34-35.

The interest of the taxpayer in the gas in place here meets all these requirements.

An economic interest in minerals in place exists when one or more of the following situations exist, as is pointed out by Professor Sneed in The Economic Interest—An Expanding Concept in 35 Texas Law Review 307, 335 (1957) :

(1) When the taxpayer has legal or equitable ownership of the minerals in place.
(2) When his control and beneficial enjoyment of the income from the mineral deposit are such as to warrant considering him the substantial owner, in the tax sense, of a part or the whole thereof. The duration of this enjoyment is relevant.
(3) WTien permitting depletion on the income from the interest would serve the purposes for which the allowance was created. The taxpayer’s contribution to discovery, development or operation is relevant.

In my opinion, the taxpayer qualifies in the instant case for the depletion allowance under the first two of these situations, and perhaps under the third, as well. This court based its second CBN decision, and now its decision here, on a phase or tangential refinement of the third situation, namely, the court-created doctrine of “essentiality” of the efforts or acts of the taxpayer as a contribution to the extraction of the mineral. It is by this doctrine that the courts can grant or deny the allowance according to the will of the court rather than according to the will of Congress. It is unfortunate that the court, and perhaps the parties as well, appeared to lose sight of the main issues and principles in this case by becoming enmeshed in the arguments and discussions of “essen-tiality.” After all, this is only one small part of the case and is not the only way a taxpayer can have an economic interest in the minerals in place.

It is my view that the taxpayer in this case met the requirements of Palmer v. Bender, supra, and Commissioner v. Southwest Exploration Co., supra, by acquiring by investment an interest in the gas in place, and by securing by legal relationship income derived from the extraction of the gas, to which it must look for a return of its capital. The tax refund sought here is based entirely on revenues derived from the interest of the taxpayer in gas produced and sold by Shamrock to third parties. None of the gas was purchased by the taxpayer.

I would enter judgment for the plaintiff by allowing it the depletion allowance claimed.

I do not reach the capital assets — long term capital gain claim of the plaintiff.

ColliNS, Judge, took no part in the decision of this case.

Findings or Fact

1. The plaintiff Sylvan C. Coleman (hereinafter referred to as “the Trustee”) is a citizen and resident of the United States, and his post office address is One Chase Manhattan Plaza, New York, New York.

2. The plaintiff Ashland Oil & Kefining Company (hereinafter referred to as “Ashland”) is a corporation organized and existing under the laws of the State of Kentucky, with its principal office and place of business at 1409 Winchester Avenue, Ashland, Kentucky.

3. Jurisdiction of the subject matter is conferred upon this court by Section 1491, Title 28, U.S. Code.

4. This action is brought for the recovery of income taxes collected from United Carbon Company, Inc. (Maryland), (hereinafter referred to as “the taxpayer”) for the calendar year 1953, as set forth in subsequent findings.

5. Throughout 1953, the taxpayer was a corporation incorporated and doing business under the laws of the State of Maryland. All its stock was owned by United Carbon Company (hereinafter referred to as “United”), a Delaware corporation.

6. A merger of the taxpayer into its parent, United, was accomplished on February 19, 1963, in compliance with Sections 66, 67, and 69 of the Maryland General Corporation Law and Section 253 of the Delaware Corporation Law, so that United succeeded to the rights of the taxpayer to prosecute this claim. Two other corporations were also involved in the merger.

7. A plan for the complete liquidation of United was adopted by its stockholders on February 20,1963. Pursuant to such plan, substantially all the assets and properties of United which could be legally transferred were sold and transferred to Ashland and others on February 28, 1963. United was dissolved on December 31, 1963.

8. By order of the Court of Chancery of the State of Delaware in and for New Castle County, entered February 17, 1964 in Civil Action No. 1933 (1964), the Trustee was appointed trustee on behalf of the stockholders of United. Such order vested in the Trustee all the right, title, and interest of United in all its assets and properties, and authorized the Trustee to prosecute all suits and claims held by United in its name or otherwise. The Trustee, accordingly, has succeeded to the rights formerly held by United to prosecute this proceeding.

9. In connection with the sale of its assets to Ashland and others, referred to in finding 7, United agreed to transfer to Ashland any proceeds which might be received from the claim asserted in this proceeding.

10. The taxpayer kept its books and reported its income for Federal tax purposes on the accrual and calendar year basis.

11. On or about March 15, 1954, the taxpayer filed its Federal corporate income tax return for 1953 with the District Director of Internal Bevenue at Parkersburg, West Virginia (hereinafter referred to as “the District Director”). The return showed an income tax liability of $979,110.93, which was duly paid by the taxpayer in installments on or about the 15th day of March, June, September, and December of 1954 to the District Director.

12. (a) On or about December 16, 1957, the District Director completed an examination of the taxpayer’s income tax return for 1953, and determined a deficiency of income tax in the amount of $28,376.18, which, together with interest in the amount of $6,496.59, a total of $34,872.77, was assessed on January 8,1958. Such deficiency assessment of $34,872.77 was paid by the taxpayer on or about February 25, 1958.

(b) Thereafter, an additional deficiency of income tax in the amount of $8,796.62 was determined, which, together with interest in the amount of $2,250.35, a total of $11,046.97, was assessed on June 20, 1958. Such additional assessment was paid by the taxpayer on or about June 27,1958.

(c) Both of the payments referred to in this finding were made to the District Director.

13. Pursuant to Section 276(b) of the Internal Bevenue Code of 1939, the District Director and the taxpayer duly and timely entered into agreements on U.S. Treasury Form 872, from time to time, extending the period of limitations within which the District Director could make a deficiency assessment for 1953. The last such agreement extended the period for assessment until June 30,1961. By virtue of Section 322(b) (3) of the 1939 Code, such agreements had the effect of extending the period of limitations on the filing of claims for refund by the taxpayer until December 31, 1961.

14. (a) On or about October 28,1959, the taxpayer made and duly filed with the District Director a timely claim for refund of an overpayment of income tax for 1953 in the amount of $38,964.10, or such greater amount as is legally refundable, together with statutory interest thereon. The claim for refund alleged that the taxpayer was entitled to an additional deduction for percentage depletion in the amount of $57,185.76, under Sections 23 (m) and 114(b) (3) of the 1939 Code, on account of royalty payments to the taxpayer from The Shamrock Oil and Gas Corporation (hereinafter referred to as “Shamrock”) in the amount of $207,948, which additional deduction was not claimed by the taxpayer on its income tax return for 1953.

(b) On or about February 8,1960, the taxpayer made and duly filed with the District Director a timely amendment to its previous claim for refund for 1953 in the amount of $38,964.10, or such greater amount as is legally refundable, together with statutory interest thereon. The amendment alleged, in the alternative, that if the payments to the taxpayer from Shamrock in the amount of $207,948 were not subject to percentage depletion, such payments should be treated as gross income from the sale of a capital asset or property used in the trade or business and held for more than 6 months, and should be subject to tax as long-term capital gain under subsections (a) and (j) of Section 117 of the 1939 Code. The amendment claimed a refund of approximately $38,000 or more, together with interest.

(c) The District Director issued a statutory notice of dis-allowance of the taxpayer’s claim for refund for 1953 and amendment on March 24,1961.

15. On March 11, 1963, the Commissioner of Internal Revenue executed an agreement with the taxpayer, pursuant to Section 3774(b) (2) of the 1939 Code, suspending the running of the period of limitation specified in Section 3772 of the 1939 Code on the bringing of suit by the taxpayer on the claim for refund. Such suspension was from March 11,1963 to the date of final decision in the case of CBN Corporation (formerly Columbian Carbon Company) v. United States, No. 243-59, then pending before this court, both dates inclusive. This court entered its decision in the CBN case on February 14, 1964 (164 Ct. Cl. 540, 328 F. 2d 316).

16. The chain of events leading up to the present litigation began in October 1935. At that time, Shamrock was engaged in the production of natural gas from lands owned or leased by Shamrock in Moore County, Texas, and in the extraction of the heavier liquid or liquefiable hydrocarbons from the natural gas. The extraction process was performed at a plant which Shamrock operated in Moore County, Texas, and which was known as the McKee Plant.

17. (a) Baw natural gas is the gas as it comes from the well. Paw natural gas is composed of various hydrocarbons in a gaseous state. These hydrocarbons include methane, ethane, propane, isobutane, normal butane, isopentane, normal pentane, and hexane. The raw natural gas, as it comes from the well, is sent to a plant containing absorbers, where the gas is processed for the extraction of natural gas liquids (i.e., propane, isobutane, normal butane, isopentane, normal pentane, and hexane).

(b) Residue gas is that portion of the raw natural gas which remains after the extraction of the liquid or lique-fiable hydrocarbons that are present in raw gas. Residue gas, therefore, is a product of raw natural gas, as are the natural gas liquids themselves. Residue gas is largely composed of methane. As a result of the liquid extraction, a cubic foot of raw natural gas will be reduced to slightly less than a cubic foot of residue gas. The ratio of the hydrocarbon components in residue gas is different from that in raw gas, because of the extraction of a large part of the liquid or liquefiable hydrocarbons.

(c) The hydrocarbon components themselves are not altered in physical or chemical characteristics by the separation process.

(d) The physical properties and composition of residue gas and raw natural gas are somewhat different, due to the extraction of the liquid or liquefiable hydrocarbons.

18. (a) The taxpayer is the successor by reorganization to Reliance Carbon Company, Inc. (hereinafter referred to as “Reliance”). On October 1,1935, Shamrock entered into an agreement with Reliance, which was engaged in the manufacture of carbon black. Under this agreement. Reliance agreed to construct, in the vicinity of Shamrock’s McKee Plant, a plant for the manufacture of carbon black that would have a capacity to handle a minimum of 30,000,000 cubic feet of natural gas per day. The agreement also provided that Shamrock (referred to in the agreement as “Seller”) would sell to Reliance (referred to in the agreement as “Buyer”), and that the latter would purchase from Shamrock, a daily minimum of 30,000,000 cubic feet of residue gas (i.e., natural gas from which the liquid and liquefiable hydrocarbons had been removed by Shamrock). The term of the agreement was for the entire life of Shamrock’s natural gas reserves in Moore County, Texas.

(b) The agreement referred to in paragraph (a) of this finding further provided in part as follows:

6. It is understood and agreed that all of the said gas so to be delivered by Seller to Buyer shall be used by Buyer in the manufacture of carbon black, except (1) so much thereof as may be necessary for the operation of the said carbon black plant and for nse in the dwellings of employees of the Buyer, and (2) that said gas may be resold by Buyer upon the following terms and conditions:
Buyer shall have the right at any time to cease burning all or any part of the gas it has been burning, and resell for other purposes said gas, or such part thereof as it ceases to bum, at the price of not less than two (20) cents per thousand cubic feet, and in the event of such resale Seller shall receive said base price of two (20) cents per thousand cubic feet to take care of royalties, lease expenses, etc., and the remainder of the said resale price shall be divided between the parties hereto in the proportion of fifty per cent (50%) thereof to Buyer and fifty percent (50%) thereof to Seller. If Buyer at any time is prevented by law from burning all or any part of the gas which it has been burning and is unable to make resale thereof when so prevented, and Seller is later able to make sale thereof, Buyer shall be entitled to the same part of the proceeds of sale as if it had negotiated or effected said sale.
* * $ 4> *
8. The duration of this agreement shall be the duration of the natural gas resources of Seller at any time legally available for the manufacture of carbon black derived from sources owned or controlled by it (including purchase or processing agreements) located in Moore County, Texas, or tributary to gasoline extraction plants of Seller located in Moore County, Texas. * * *
* * * * *
14. The price to be paid to Seller for gas delivered to Buyer shall be 30% of the carbon black production of Buyer’s plant, hereinafter referred to as royalty, which shall, at Buyer’s expense, be placed in Buyer’s warehouse in paper bags, uncompressed. * * *
* Ms * » *
18. All rights and obligations hereunder shall extend to and be binding upon the parties hereto, their successors and assigns. It is further agreed that the provisions of this agreement regarding the production and delivery of gas by Seller, and the acceptance and payment for same by Buyer, shall be deemed to be covenants running with the respective lands, leases, purchase agreements, plants and pipe lines, together with their appurtenances, of the parties hereto. And the parties hereto covenant that they will not dispose of any of same in bulk, or in suck material part as to disable them from performing their obligations hereunder, without causing the party to whom such property shall be transferred, together with its successors and assigns, to assume and be bound by the terms hereof. Provided, however, that nothing herein contained shall prevent Seller from selling, trading or abandoning any lease or gas contract in the ordinary course of business, or of exchanging any part of its gas resources for other gas resources of substantially equal amount.

19. An agreement similar to the one referred to in finding 18 was entered into on October 1, 1935 between Shamrock (as “Seller”) and the Western Carbon Company (as “Buyer”).

20. In connection with the agreements referred to in findings 18 and 19, Shamrock, Eeliance, and Western Carbon Company entered into a subsidiary agreement, also dated October 1, 1935. In this subsidiary agreement, Shamrock granted to Eeliance and to Western Carbon Company “* * * the first right, in priority to all other uses or dispositions of its natural gas made by * * * [Shamrock] in twelve thousand (12,000) acres of gas territory owned or controlled by * * * [Shamrock] and located in Moore County, Texas.” The subsidiary agreement further provided (among other things) that “All rights and obligations hereunder shall extend to and be binding upon the parties hereto, their sue-, cessors and assigns.”

21. Subsequent to the making of the agreements referred to in findings 18 'and 20, Eeliance constructed in Moore County, Texas, a carbon black plant that had a capacity sufficient to handle a minimum of 30,000,000 cubic feet of natural gas per day. The plant was located in the general vicinity of Shamrock’s McKee Plant. The cost of the carbon black plant was approximately $890,000.

22. The taxpayer subsequently succeeded to all of Eeliance’s rights in the agreements referred to in findings 18 and 20.

23. (a) By means of an agreement dated November 19, 1946 between Shamrock and the taxpayer, Shamrock agreed to “* * * increase the acreage reserves from which the Buyer [the taxpayer] has the prior right to purchase and receive gas under tbe Gas Sales Agreement dated October 1,1935, by an additional amount of 2,170 acres * *

(b) The agreement of November 19,1946 amended paragraph 6 of the agreement mentioned in finding 18 by substituting “three cents (30)” for “two (20) cents” wherever the latter appeared in the paragraph.

(c) The agreement of November 19, 1946 substituted for paragraph 14 of the agreement mentioned in finding 18 a provision calling for the payment of a fixed price per Mcf on the gas delivered by Shamrock to the taxpayer after January 1, 1946. The price was to increase gradually in accordance with the following schedule:

Period Pri7oZs)Uot
Jan. 1-July 31, 1916_2.435
Aug. 1, 1946-Dec. 31, 1947_3
Jan. 1, 1948-Dee. 31, 1952_4
Jan. 1, 1953-Dec. 31, 1957_4.25
After Jan. 1, 1958_5.5

24. Further amendatory agreements were entered into between Shamrock and the taxpayer on August 28, 1947 and July 1, 1949. One result was that the provisions of earlier agreements relative to the amount of natural gas that was to be sold by Shamrock and purchased by the taxpayer, and the extent of Shamrock’s gas reserves that should be dedicated to this relationship, were superseded by a provision reading in part as follows:

* * * The aggregate volumes of residue gas which Buyer [the taxpayer] has the prior right to purchase and which Seller [Shamrock] has the obligation to sell and deliver to Buyer * * * is the fractional part of the residue gas remaining (after being processed for the recovery of liquid hydrocarbons in either Seller’s McKee plant or Sunray plant, located near Sunray, Moore County, Texas) from gas produced from “Seller’s sour gas reserves” * * * represented by a fraction, the numerator of which is 8,170 and the denominator of which is 62,625. Said fractional part of said residue gas is hereinafter referred to as the “dedicated reserves” of Buyer. It is agreed, however, if there shall be available from such dedicated reserves of Buyer in excess of twenty-eight million (28,000,000) cubic feet daily, averaged monthly, Buyer shall not be obligated to purchase in excess of twenty-eight million (28,000,000) cubic feet daily, but shall 'be privileged to purchase, by notifying Seller in writing of its desire to so purchase, the volumes attributable to the reserves of Buyer up to thirty million (30,000,000) cubic feet daily when such volumes are available from such source * * *.

25. Under the agreements with Shamrock as they existed in 1952, as amended, the taxpayer had the right—at any time—to cease burning in the manufacture of carbon black, and to resell, a portion of the residue gas purchased from Shamrock and dedicated to the taxpayer. The portion of the residue gas which could be resold was 6,000/62,625ths of Shamrock’s sour gas reserves in Moore County, Texas.

26. (a) Prior to October 15,1952, the taxpayer gave notice to Shamrock that it intended to shut down the carbon black plant, that it desired to be relieved of purchasing the volumes of residue gas it was required to purchase under the gas sales agreement of October 1, 1935, as amended, but which it did not have the right to resell, and that it desired to effect a resale of the volumes of residue gas that it was authorized to resell under the terms and provisions of the gas sales agreement of October 1,1935, as amended.

(b) On October 15,1952, Shamrock negotiated a contract, effective September 1,1953, for the sale of gas—including gas from the acreage previously dedicated for the life of the field to the taxpayer —to the Northern Natural Gas Company (hereinafter referred to as “Northern”) for the following prices:

Price per Mcf Period (cents)
Sept. 1, 1953-Dec. 31, 1957_10. 5
Jan. 1, 1958-Dee. 31, 1962_11. 5
After Jan. 1, 1963_12. 5

27.On November 19, 1952, Shamrock and the taxpayer entered into an agreement that superseded and terminated the prior agreements between the parties. This agreement provided in part as follows:

Whekeas United has notified Shamrock of its intention to shut down its carbon black plant in which the residue gas purchased by United from Shamrock is currently being burned in the manufacturing of carbon black, to the extent necessary for the burning of the volumes of residue gas it is authorized to resell as above provided, and that it desires to completely shut down said plant and be relieved of purchasing the volumes of residue gas it is required to purchase under the aforesaid contracts but which it does not have the right to resell, and, further, that it desires to effect a resale of the volumes of gas it is authorized to resell under the terms and provisions of the aforesaid contracts; and
WheReas it is recognized that any purchaser of such residue gas must receive same at the boundary of Shamrock’s McKee Plant * * *, and that the conditions under which such volumes would be delivered and received would require an agreement or arrangement between Shamrock and the purchaser * * *; and the parties hereto, having considered such matters, have concluded that it would be more economical and convenient to arrange for the resale of the aforesaid volumes to be made by Shamrock in its own name * * *; and
Wheeeas Shamrock is willing to release United from its obligations to purchase volumes of residue gas it is now obligated to purchase under the aforesaid contracts over and above the volumes United is authorized * * * to resell, and is willing to undertake to accomplish a resale of the volumes of residue gas which United is authorized to resell * * * in lieu of making delivery thereof to United, and is willing to make certain payments to United with respect to the volumes of residue gas remaining from gas produced from its sour gas reserves to the extent of the volumes which United would, except for this contract, be authorized to sell to others; * * *
* * * * £
Now, therefore, in consideration of the premises and of the terms and provisions hereof, the parties hereto agree between themselves as follows:
1. Effective September 1, 1953, the aforesaid agreements and contracts between Shamrock and United (or its predecessor) shall be terminated and be and become of no further force and effect, except as to final accounting between the parties thereto with respect to sales and deliveries of residue gas and related matters thereunder consummated prior to September 1,1953, and thereafter this contract and the provisions hereof shall fully control the rights, duties and obligations of the parties hereto with respect to the subject matter of the aforesaid contracts.
2. Shamrock agrees that it will pay to United, as hereinafter provided, certain monetary considerations in respect of certain volumes of residue gas hereinafter specified, subject to the provisions hereinafter contained.
Tbe volumes of residue gas upon which payments will accrue and are to be made by Shamrock to United shall be that part of all of the residue gas remaining from gas produced on and after September 1, 1958 from Shamrock’s sour gas reserves * * * from gas wells having a shut-in pressure of more than fifty (50) pounds per square inch gauge represented by a fraction, the numerator of which is 6,000 and the denominator of which is 62,625.
3. In determining the volumes of residue gas remaining from gas produced from Shamrock’s sour gas reserves there shall be deducted from gas produced therefrom:
(a) All liquids or liquefiable hydrocarbons extracted or removed by Shamrock from such production;
(b) All volumes of gas reserved to lessors under the provisions of oil and gas leases referred to on Schedule A attached hereto;
(c) Such volumes of gas produced from such reserves and used for drilling wells for the production of oil and gas and for maintenance and operation of the leases and the production of oil and gas from the lands referred to in Schedule A attached hereto; and
(d) The proportionate part of gas produced from said reserves that the total volumes of gas produced therefrom bear to the total volumes of all gas gathered and processed by Shamrock for the recovery of liquid hydrocarbons at its McKee and Sunray Plants in Moore County, Texas (or other plants where any part of the gas from such reserves is processed for liquid hydrocarbons) that may be lost or used in such processing (including the removal of hydrogen sulphide therefrom) through line and gathering losses, volumes used for fuel for compressors and compressor stations (except compressor fuel required to deliver casinghead gas into Shamrock’s main line gathering system), volumes for fuel for plants for recovery, fractionating and processing liquids and liquid hydrocarbons and hydrogen sulphide from the gas and in the manufacturing of elemental sulphur and for steam in connection with such purposes, houses of employees and offices of Shamrock in the field.
4. There shall be no restriction nor limitation on Shamrock’s right to remove liquid or liquefiable hydrocarbons or hydrogen sulphide from the gas produced from said reserves and there shall be no obligation, express or implied, on Shamrock’s part to make payments to United on the proportionate part of said residue gas above specified, except as, if and when such residue gas is sold or used by Shamrock for purposes other than specified in subparagraphs (a), (b), (c) and (d) of Section 3 above; provided that if Shamrock should cease to process through its plant or plants the gas produced from its sour gas reserves, or any part thereof, and shall make sale thereof at the well or wells where produced, then such payments shall be applicable to the proportionate part of the raw gas volumes that may be sold by Shamrock.
5. Shamrock shall have the right to surrender, release or abandon any of such reserves and plug any well or wells thereon, if, in its opinion, it would not be profitable for it to retain said premises or such well or wells. Shamrock does not warrant its title to any of such reserves, but does warrant title to all gas it may produce and sell therefrom and agrees to indemnify United with respect to the gas so produced and sold or used by Shamrock therefrom; it being understood that United does not warrant any title thereto for the benefit of Shamrock or others. In the event any such leasehold acreage constituting a part of Shamrock’s sour gas reserves is released, surrendered, abandoned, terminated or lost by reason of failure in title, then Shamrock shall not be liable to United with respect thereto, and in such event or events Schedule A attached hereto shall automatically be deemed revised to eliminate therefrom the premises covered by any such release, surrender, abandonment or loss.
$ 7. Payments which Shamrock agrees to make to United with respect to the volumes of residue gas upon which payments are to be made by Shamrock to United as specified in this contract shall be:
(a) Subject to the adjustment in payment with respect to certain volumes of residue gas to be made as is provided in subparagraph (o) of this Section 7 below, Shamrock agrees to pay to United, monthly, Six Cents (60) per one thousand (1,000) cubic feet for the volumes of residue gas upon which payments are to be made hereunder; provided, however, it is understood that under the terms of said gas sales agreement between Shamrock and Northern it is provided that Shamrock shall receive a sales price for the residue gas (sweet or sweetened, but exclusive of compression charge), on and after September 1, 1953, of not less than Ten and One-half Cents (101/20) per thousand cubic feet, and if the price of such gas sold and delivered by Shamrock to Northern should hereafter be disallowed or reduced to any extent below Ten Cents (100) per thousand cubic feet by order, rule or regulation of any governmental authority having jurisdiction, then the payments which Shamrock shall be obligated to make to United hereunder shall be reduced concurrently to the extent of one-half (%) of the disallowance or reduction below Ten Cents (100) per thousand cubic feet for the duration of such disallowance or reduction. ‡ ‡ ‡
9. Shamrock will pay all ad valorem taxes on its leases and on its properties. No portion of gross production taxes, severance taxes or other excise taxes levied prior to March 1, 1950 upon or with respect to the volumes of residue gas in respect of which Shamrock shall become obligated to make payments to United hereunder shall be borne by United. United agrees to pay to Shamrock, when billed by Shamrock, sums equal to one-sixth (%) of seven-eighths (%) of all increases, effective March 1,1950 and thereafter, m such present gross production taxes, severance taxes and other excise taxes upon, and one-sixth (%) of seven-eighths (%) of any new or additional excise taxes levied upon or with respect to, the volumes of residue gas in respect of which Shamrock may be required hereunder to make payments to United or the production, transportation or handling thereof. If any such tax is imposed upon or with respect to raw gas from which residue gas is attributable, the portion of such tax attributable to such residue gas for the purposes hereof shall be represented by a fraction, the numerator of which is the volume of such residue gas and the denominator of which is the volume of such raw gas; that is, for example, if a new or increased tax is imposed with respect to a unit of one thousand (1,000) cubic feet of raw gas from which nine hundred fifty (950) cubic feet of residue gas is attributable in respect of settlement to; United hereunder, United shall pay one-sixth (%) of seven-eighths (%) of 950/1,000 of the tax imposed on such unit of one thousand (1,000) cubic feet of gas. Provided, however, if such tax or taxes should hereafter eliminate or not include royalty owners as taxpayers thereunder, then the fraction of seven-eighths (%) first above used in this paragraph shall be increased to eight-eighths (%) with respect to any such tax.

28. By a letter agreement among the taxpayer, Columbian Carbon Company, and Shamrock dated December 16, 1952, the agreement dated November 19, 1952 was amended so as to make it effective as of January 1,1958.

29. (a) Pursuant to the agreement dated November 19, 1952, as modified by the letter agreement dated December 16,1952, payments in the amount of $207,948 from Shamrock accrued to the taxpayer during the calendar year 1953, as follows:

Month Amount Due the Taxpayer
January — __ $16, &20
February . _ 14,793
March_ __ 16,226
April_ 15,250
May_ __ 14,881
June_ — 15,148
July- — 14,207
August_ __ 12,792
September 22,043
October __ 20,947
November __ 23,220
December 21,521
$207,948

(b) The $207,948 referred to in paragraph (a) of this finding was reported by the taxpayer in its income tax return for 1953 as ordinary income. No deduction for percentage depletion was claimed by the taxpayer in its return with respect to such item.

30. At all times material hereto, the taxpayer was engaged primarily in the business of manufacturing carbon black. In this connection, it entered into contracts to purchase gas and other feedstocks. The taxpayer did not ordinarily enter into or acquire contracts for the purchase of gas with a view to effecting a resale thereof.

31. Prior to 1953, the taxpayer did not claim in its income tax returns as filed (or subsequently) that it was entitled to any deductions for depletion with respect to the agreements with Shamrock mentioned in previous findings.

32. In determining income from gas sales, Shamrock during 1953 treated the sale of residue gas to Northern under the gas sales agreement referred to in finding 26(b), insofar as such gas sales agreement covered the “resale volumes” referred to in the November 19, 1952 agreement, in the following manner: Each entry in Shamrock’s books of account crediting amounts received from Northern under the gas sales agreement to its “residue gas pipeline sales” account was accompanied by a contra charge representing the amount considered by Shamrock as having been received on behalf of United for the “resale volumes.” This treatment was followed by Shamrock in determining its income from gas sales for Federal income tax purposes, and, accordingly, the amounts considered by Shamrock as having been received on behalf of United for the “resale volumes” were not considered to be income to Shamrock and were not included in the gas sales income of Shamrock.

33. The production from the leases involved in the November 19,1952 agreement was not sold at the wells, but instead was gathered to a central point, where it was processed in a natural gasoline plant, after which the “residue gas remaining” was sold at the tail of the plant and the extracted liquids and other products were sold or otherwise disposed of. Depletion was not claimed on the amounts received for the sale of residue gas, since these amounts were not deemed to represent “gross income from the property” under the Internal Revenue Code, but, rather, were proceeds from the sale of residue gas remaining after processing, as distinguished from raw gas sales at the wellhead. Shamrock computed the value of the raw gas at the wellhead in order to arrive at the “gross income from the property.” As a first step in this computation, it was necessary to determine Shamrock’s interest in the production.

34. Shamrock has always claimed a depletion allowance on its entire working interest production volume in the leases referred to in the November 19, 1952 agreement. It has always been Shamrock’s position that its working interest was not diminished or altered because of the November 19, 1952 agreement. Shamrock claimed depletion on its entire working interest at all times prior to and subsequent to the execution of the November 19, 1952 agreement. As an example, Shamrock’s working interest in its Tays lease, one of the leases referred to in the November 19, 1952 agreement, was both before and after the execution of the November 19,1952 agreement a full %ths working interest, the remaining %th being owned by the lessor-landowner.

35. As an example of the first step in computing “gross income from the property,” Shamrock’s records reflect that during Shamrock’s fiscal year 1953, Shamrock multiplied the entire gross production from the well on the Tays lease (1,296,060 Mcf) by the fraction %, representing Shamrock’s working interest, to determine its working interest production (1,134,053 Mcf). The Internal Revenue Service issued assessments for certain taxable years, including the fiscal years that ended on November 30 of 1952,1953, and 1954, but did not question the right of Shamrock to claim depletion on the entire working interest volume from the leases referred to in the November 19,1952 agreement. In order to complete the computation of “gross income from the property,” it was then necessary to apply a unit value (cents per Mcf) to the working interest production. There has been difficulty in determining the unit value to be applied to the working interest production because of the provisions of the income tax regulations to the effect that the “gross income from the property” in the case of gas wells is the amount for which the gas is sold “in the immediate vicinity of the well.” If the gas is not “sold on the property” but is “manufactured or converted into a refined product prior to sale,” or if it is “transported from the property prior to sale,” the gross income from the property is to “be assumed to be equivalent to the representative market or field price (as of the date of sale)” of the gas “before conversion or transportation.”

36. The question of the unit value at the wellhead of gas produced by Shamrock and processed through its own gasoline plant has been the subject of controversy between Shamrock and the Internal Revenue Service for many years. The question has been litigated in the Tax Court of the United States. The years involved in that litigation were the taxable years that ended on November 30 of each of the years 1943 through 1954. Under the decision in Shamrock’s Tax Court case (35 T.C. 979), which has been affirmed by the U.S. Court of Appeals for the Fifth Circuit (346 F. 2d 377), it was concluded that the gas produced from the leases referred to in the November 19, 1952 agreement was not sold “in the immediate vicinity of the wells,” but that it was transported from the properties and manufactured or converted into a refined product prior to sale; and, therefore, the “gross income from the property” was assumed to be equivalent to the “representative market or field price (as of the date of sale) ” of the raw gas at the well mouth. Under the Tax Court decision, the “representative field or market price” was determined by reference to certain wellhead sales of raw gas (not residue gas sales), and a unit price (cents per Mcf) was established and applied to Shamrock’s working interest volumes. This unit price for raw gas at the well has no relationship to amounts received for residue gas and other products derived from the processing operation. In the case of the Tays well, this unit price (6.49356 cents per Mcf) was (in the Hule 50 computation for Shamrock’s fiscal year 1953) multiplied by Shamrock’s full working interest (%) mentioned above (1,134,053 Mcf), and the result ($73,640.41) was Shamrock’s “gross income from the property” for percentage depletion purposes, and Shamrock was allowed 27% percent ($20,251.11) of such “gross income from the property” as percentage depletion for the Tays well for that year.

37. In the preparation of its Federal income tax returns for the taxable years 1952, 1953, and 1954, Shamrock used what is sometimes referred to as the “realization” method for valuing its processed gas production. The gross value of the production was assumed to be 100 percent of the value of the residue gas and 40 percent of the value of the liquid product output of the gasoline plants. The total gross value was divided by the total gas production to determine the unit value. The unit value was applied to Shamrock’s working interest production from the various leases to determine the “gross income from the property.” In determining 100 percent of the value of the residue gas, Shamrock considered the value of the residue gas sold to be the amount which it actually received for the sale of the residue gas. Prior to the execution of tire November 19, 1952 agreement, this was the amount for which the gas was sold to United. Subsequent to the execution of the November 19, 1952 agreement, the value was considered to be the amount which Shamrock received from Northern, less the contra charge representing the amount considered by Shamrock as having been received on behalf of United for the “resale volumes.”

38. In the litigation of the depletable value of its processed gas, Shamrock contended (among other things) that the value should be determined by use of the “work-back” or “proportionate-profits” method. The total wellhead value of the production was assumed to be 100 percent of the value of the residue gas and liquid products, less the cost of gathering and processing the gas. The 100 percent value of the residue gas was determined in the same manner as described under the “realization” method mentioned in finding 36. This procedure was rejected by the Tax Court.

39. It has been agreed by the parties, with the approval of the commissioner, that if, under all the circumstances, the court determines that the plaintiffs are entitled to recover under either of the plaintiffs’ alternative contentions, then the amount of the recovery is to be determined pursuant to Rule 47(c). Neither party was required at the trial to present any evidence as to the amount of any probable refund to which the plaintiffs may be entitled by virtue of a decision by the court favorable to the plaintiffs. Such amount of refund, if any, plus interest thereon according to law, will be recomputed by the defendant in accordance with its normal procedures, and the right is reserved to the plaintiffs to have the court recompute the amount in the event the plaintiffs shall not be satisfied with the defendant’s recomputation.

40. No action or other suit has been commenced or is pending in any other court on account of this claim, and no action has been had thereon in Congress or by any of the executive departments or agencies, other than as herein stated.

CONCLUSION op Law

Upon the foregoing findings of fact and opinion, which are adopted by the court and made a part of the judgment herein, the court concludes as a matter of law that the plaintiffs are not entitled to recover, and the petition is dismissed. 
      
      The concurring opinion of Lakasioee, Judge, and the dissenting opinion of Skelton. Judge, follow the opinion of the Trial Cmmissioner which has been adopted by the court.
     
      
      The opinion, findings of fact, and recommended conclusion of law are submitted under the order of reference and Rule 57(a).
     
      
       Plaintiffs say that In the OBN oases this court was not apprised that the Texas conservation laws, in 1935, made the carbon black plants essential to the production of the gas and therefore gave plaintiffs’ predecessor an economic interest in the gas in place under the doctrine of Commissioner v. Southwest Exploration Co., supra. The Fifth Circuit has rejected this contention, holding that the state conservation laws did not prevent the sale or marketing of the gas, and in effect that carbon black plants were not essential to production. Scofield v. La Gloria Oil & Gas Co., 268 F. 2d 699, 708 (5th Cir., 1959), cert. denied, 361 U.S. 933 (1960) ; Shamrock Oil & Gas Corp. v. Commissioner, 346 F. 2d 377, 379-80 (5th Cir., 1965), cert. denied, 382 U.S. 892. There is no reason to disagree with the Fifth Circuit.
     
      
       For a discussion of the case, see Eustice, Contract Rights, Capital Gain, and, Assignment of Income—the Ferrer Case, 20 TAX L. REV. 1 (1964).
     