The voting capital stock of the petitioner during the entire year 1926 and the voting capital stock of Farr's Clothes, Inc., from January 22, 1926, to December 31, 1926, was owned as follows:

Frank Cerney, a minority stockholder of the petitioner company, was employed by the petitioner's predecessor in 1905 and has been employed in the business continually since that time. He is at present the petitioner's "head designer and factory superintendent."

All of the petitioner's stockholders were elected directors and no dissenting votes were ever cast. All the stockholders of Farr's Clothes, Inc., were elected directors and no dissenting votes were ever cast.

The petitioner and Farr's Clothes, Inc., during 1926, had the same officers, namely, William Schnurmacher, president and treasurer, and Howard Liebenthal, secretary.

All of the preferred capital stock of Farr's Clothes, Inc., is owned by William Schnurmacher and Howard Liebenthal in equal shares. The preferred stock has no voting rights.

The selling price of the manufactured articles and the margin of profit for each company was determined by the "same interests" and the accounting records of both companies were kept in the same office. The petitioner billed all merchandise sold to Farr's Clothes, Inc., at cost, plus 18 per cent profit.

The petitioner had a net profit in 1926 of $4,581.51 and Farr's Clothes, Inc., had an operating loss for the period January 22, 1926, to December 31, 1926, of $5,588.55. At the close of 1926, Farr's Clothes, Inc., had accounts payable to the petitioner in the amount of $32,394.50, while the petitioner had accounts receivable from Farr's Clothes, Inc., in the same amount.

OPINION.

SMITH: The petitioner's sole contention in this proceeding is that it is entitled to have its income tax for the calendar year 1926 computed upon the basis of a consolidated return filed by it and Farr's Clothes, Inc., for that period. The respondent has ruled that petitioner and Farr's Clothes, Inc., were not affiliated in 1926 within the meaning of section 240 (d) of the Revenue Act of 1926. The wording of this section of the statute referred to is as follows:

For the purpose of this section two or more domestic corporations shall be deemed to be affiliated (1) if one corporation owns at least 95 per centum of the stock of the other or others, or (2) if at least 95 per centum of the stock of two or more corporations is owned by the same interests. As used in this subdivision the term "stock" does not include nonvoting stock which is limited and preferred as to dividends. This subdivision shall be applicable to the determination of afiliation for the taxable year 1926 and each taxable year therafter.

Since the petitioner did not own any of the stock of Farr's Clothes, Inc., the question to be determined is whether at least 95 per cent of the voting stock of both companies was owned by the "same interests." The stipulated facts as to stock ownership in the companies are that the three individuals, William Schnurmacher, Howard Liebenthal, and Rose Liebenthal, who owned 99.6 per cent, all but four qualifying shares, of the voting stock of Farr's Clothes, Inc., owned only 91.6 per cent of the petitioner's voting stock, and a fourth individual, Frank Cerney, owned 8 per cent of petitioner's voting stock and no stock in Farr's Clothes, Inc.

The petitioner urges, however, that in the circumstances of this case, its minority stockholder, Cerney, comprised the "same interests" with the majority stockholders. Unquestionably, there was a very close business relationship between them. Cerney was a salaried employee, as well as a stockolder of the petitioner. He had been employed by the petitioner and its predecessor for many years. He was also a director of the petitioner and was in complete harmony with the majority stockholders. He held his stock in the petitioner under an agreement which prohibited him from disposing of it without first offering it to the other stockholders at its book value. Notwithstanding these considerations, however, we can not agree that Cerney and the petitioner's other stockholders, who owned 99.6 per cent of the stock of Farr's Clothes, Inc., constituted the same interests within the meaning of the statute. The courts have construed the words "same interests" as meaning the same "beneficial interests." Commissioner v. Hirsch & Co., 30 Fed. (2d) 645; Handy

& Harmon v. Commissioner, 284 U. S. 136. In the latter case the Supreme Court said:

The purpose of Sec. 240 was, by means of consolidated returns, to require taxes to be levied according to the true net income and invested capital resulting from and employed in a single business enterprise even though it was conducted by means of more than one corporation. Subsection (b) clearly reflects the intention, by means of such returns, to secure substantial equality as between shareholders who ultimately bear the burden. That intention is shown by the legislative history and was given effect by the regulations contemporaneously promulgated. It requires no discussion to show that such returns will not make against inequality or evasion unless the same interests are the beneficial owners in like proportions of substantially all of the stock of each of such corporations. Alameda Investment Co. v. McLaughlin, 28 F. (2d) 81. Montana Mercantile Co. v. Rasmusson, 28 F. (2d) 916. Commis sioner v. Adolph Hirsch & Co., 30 F. (2d) 645, 646. Commissioner of Internal Revenue v. City Button Works, 49 F. (2d) 705.

Cf. also Commissioner v. Gong Bell Mfg. Co., 48 Fed. (2d) 205; certiorari denied, 284 U. S. 670.

Obviously, the conditions existing with respect to the ownership of the voting stock of the petitioner and Farr's Clothes, Inc., in 1926 do not meet the test laid down by the Supreme Court for affiliation. Cerney, not being a stockholder in Farr's Clothes, Inc., would neither have benefited by a gain nor shared a loss of that company. See also East Jersey Lumber & Timber Co., 24 B. T. A. 1047; J. P. Burton Coal Co., 24 B. T. A. 1052.

Judgment will be entered for the respondent.

WESLEY G. ROGERS, PETITIONER, V. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

BASCOM H. ROGERS, PETITIONER, D. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket Nos. 41894, 41895. Promulgated February 9, 1932.

Amounts received by owners of mineral rights as bonus upon
execution of a lease to develop such rights on a royalty basis are
income in their entirety at the dates received.

Charles H. Garnett, Esq., for the petitioners.
Maxwell M. Mahany, Esq., for the respondent.

OPINION.

LANSDON: The petitioners herein are members in equal interest of a partnership. At Docket Nos. 41894 and 41895 the respondent has asserted deficiencies in income tax for the year 1926 against Wesley .G. Rogers and Bascom H. Rogers in the respective amounts of $2,

062.70 and $2,044.19. Several assignments of error are made in each petition, but at the hearing all were abandoned except the allegation that the Commissioner erred in the inclusion of certain amounts received by the partnership as bonuses on oil and gas subleases. The two proceedings were consolidated for hearing and decision. The facts are stipulated as follows:

The petitioners, members having equal interests in the partnership of Rogers & Rogers of Holdenville, Oklahoma, during the year 1926, were engaged in the business of purchasing undeveloped and unleased oil and gas properties, for which there was a demand for oil and gas leases thereon, pursuant to which they acquired, by purchase, either the fee title to lands believed to contain oil and gas, or the so-called royalty or mineral rights therein, all of which lands and mineral rights were located within the State of Oklahoma.

During the year 1926 they executed as lessors, with respect to such lands, oil and gas leases in the form set forth in the Oil & Gas Mining Lease designated as Mid-Continent No. 88, Revised, a copy of which is submitted herewith and made a part of this stipulation. The leases so executed were upon tracts in which the petitioners owned either the fee simple title or the entire socalled royalty or mineral interest, title to which had been acquired by them through purchase during the years 1925 and 1926. Upon none of these tracts were there as of the date of purchase or of the execution of these leases, any valid prior or existing oil and gas leases.

Pursuant to the execution of said leases the petitioners received a cash consideration, commonly referred to as a bonus. The legal description of such tracts, the character of the interest owned, the cost of such interest, and the amount received pursuant to the execution of said leases, which are for convenience referred to as Group (a) and Group (b), were as follows:

In determining the deficiencies herein, the respondent included as income the entire amount of the sums received, namely $2,359.87 and $4,777.08, and has not allowed as either a deduction or as cost any part of the sums theretofore paid by the petitioners for the fee simple title or mineral interests in the tracts involved.

The petitioners purchased oil and gas rights on divers tracts of lands in Oklahoma at costs above stipulated, and later executed oil and gas leases covering the same lands, and in each instance reserved one-eighth of the production and received a bonus. Their contention is that the amounts paid for the mineral rights were capital investment and that no profit or income inures to them until the amount of such investments has been recovered. In Group (a) the bonus received for each lease exceeded the cost of the mineral rights and they contend that their income therefrom was the difference between the cost of such rights and the bonus received upon the execution of the lease. In Group (b) in each instance the bonus received was less than the cost of the rights leased and their contention is that a loss was sustained in each transaction measured by the difference between cost and bonus. The respondent has determined the deficiency on the theory that all the bonus received in the execution of an oil and gas lease is income to the lessor.

It is now well settled the owners of mineral rights in Oklahoma lands merely own the right to go upon the land and reduce all oil and gas or other minerals to possession by exploration, development and production. They do not own the oil and gas in situs. In the same State it is held that the execution of an oil and gas lease does not convey minerals in place. Such a lease is not real property, but a chattel real. Duff v. Keaton, 33 Okla. ; 92, 124 Pac. 291; Papoose Oil Co. v. Swindler, 95 Okla. 264; 221 Pac. 506. It is also established that such a lease does not involve a sale of either real or personal property, and is no more than a contract for development. It is not necessary, therefore, to consider or follow the statute covering sales of real and personal property. Adams v. Tidal Oil Co., 237 Pac. 443. It is, of course, true that the cost of mineral rights acquired by the petitioners was a capital investment and if the execution of the lease constituted a sale, the petitioners' contention would be sound. Upon the authority of the case cited above we hold, however, that the leases were not sales, but merely licenses to the lessees for certain purposes. That the bonus received on the execution of a gas and oil lease is income is no longer an open question. In Work v. United States, 261 U. S. 352, Chief Justice Taft said:

The bonus which was the result of bidding for desirable and profitable oil and gas leases secured for the members of the Osage Tribe the just value of the use of their property which the fixing of royalties in advance by the President was not adapted to give them. It was in effect a supplement to the royalties already determined. It was really part of the royalty or rental in a lump sum or down payment. We do not see how it can be classified as anything else. It was income from the use of the mineral resources of the land. Of course, it involved a consumption and reduction of the mineral value of the land, but so does a royalty. This is an inevitable characteristic of income from the product of the mine.