Commissioner of Internal Revenue v. Southwest Exploration Co

In Commissioner of Internal Revenue v. Southwest Exploration Co., 350 U.S. 308, 76 S.Ct. 395, 100 L.Ed. 347 (1956), the Supreme Court dealt with another related aspect of this vast and complex area of oil depletion allowances. In that case, Southwest had leased the premises of uplands' owners in order to drill for offshore oil belonging to the state. It was required, by state law in California, that a driller must put his machinery on land removed from the shore and drill on a slant to the oil under the water just offshore. Neither the driller nor the landowner "owned" the oil but the driller had received an easement from the state to remove it. An agreement was reached whereby the landowner was to receive 24 percent of the net profits from production in return for the use of his land. Southwest claimed depletion on the whole production, but the Court of Claims held that the landowner could claim depletion on his portion of the proceeds. Huntington Beach Co. v. United States, 132 F.Supp. 718, 132 Ct.Cl. 427 (1955) aff'd, 350 U.S. 308, 76 S.Ct. 395, 100 L.Ed. 347 (1956). The Supreme Court affirmed the Court of Claims holding that the landowner did have an interest in the oil and he must look to the extraction of that oil for a return of his capital. Although there was no question as to the sole source of income of the landowner, the Court in Commissioner of Internal Revenue v. Southwest Exploration Co., supra, stated at page 314 of 350 U.S., at page 399 of 76 S.Ct.: The second factor has been interpreted to mean that the taxpayer must look solely to the extraction of oil or gas for a return of his capital, and depletion has been denied where the payments were not dependent on production, . In Commissioner of Internal Revenue v. Southwest Exploration Co, 350 U.S. 308, 76 S.Ct. 395, 400, 100 L.Ed. 347 (1956), the last word on the subject, the taxpayers, who owned upland drilling sites, had no legal interest whatever in certain offshore oil deposits, either in fee or in leasehold, but their drilling sites were necessary for the development of the offshore oil. The Supreme Court held that "the law of depletion requires an economic rather than a legal interest to the oil in place"; the taxpayers' contribution of drilling sites in return for a share of the net profits from the offshore wells was "an investment in the oil in place sufficient to establish their economic interest."