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that the owner's estate is quite the more valuable because he does not have to pay a one-eighth royalty to anybody. The lessee must continue to pay that one-eighth royalty, or whatever may be agreed upon, for as long a time as oil and gas can be found. But that difference is a difference not in the character of the property they hold, but merely in its value, and, of course, it is subject to definite appraisal. The existing law provides, in the case of those operators who purchased their properties prior to March 1, 1913, that they may set up the valuation of those properties as of that date, but the regulations of the Treasury Department have construed that evidently because of the occurrence of the word "purchase" in there-to mean that depletion may only be computed by an owner in fee. It is true that they allow a lessee to compute depletion

Mr. MOORE (interposing). Have you the law before you, and, if so, can you quote that section?

Mr. KELLY. I think I have made a note of that particular section. It is under the general heading of deductions that are allowed both individuals and corporations. I think the quotation is like this-it is the act of September 8, 1916, as amended by the act of October 3, 1917.

Mr. MOORE. If you have it there, I wish you would read it.

Mr. WHITE. Is it not a fact that that ruling has had the result of men putting their money into royalties rather than into deductions?

Mr. KELLY. I do not think so; because, of course, the allowance after March 1, 1913, is restricted in the case of both the owner and the lessee to the actual amount paid therefor. However, it might have that effect to some extent; but, of course, the purchasers of the royalties are a very small factor in the industry as a whole. Mr. MOORE. I wish you would quote that law.

Mr. KELLY. I will. It is section 12, paragraph 2.

The CHAIRMAN. That is in the 1916 act?

Mr. KELLY. Yes; but the same provision appears in the amended act of 1917:

In the case of oil and gas wells a reasonable allowance for actual reduction in flow and production to be ascertained not by the flush flow but by the settled production or regular flow.

I will omit the part relating to mines.

Provided, That when the allowance authorized in (a) and (b) shall equal the capital originally invested, or in case of purchase made prior to March first, nineteen hundred and thirteen, the fair market value as of that date, no further allowance shall be made.

I think that is the substance of that particular provision. So that in the case of both the owner and the lessee, after March 1, 1913, there will be a restriction as to the amounts actually paid. I am frank to say that I have not given sufficient consideration as to whether or not there ought to be some allowance made there in view of the hazardous nature of the business, but I was confining myself in my prior argument to the capital which existed on March 1, 1913. The CHAIRMAN. That is provided for in another section. In making up their income tax returns they are to consider the cost of, say, lumber or other raw materials, not as of the time they made the purchase, but the value as of March 1, 1913.

Mr. KELLY. That is what the department has held in respect to owners, but they do not let the lessee take advantage of that. In other words, they say that the lessee, even though he has a right to all the oil and gas beneath that territory for as long as those products can be found, that because of the fact that technically he is some kind of a lessee, and the other man on the other side owns his land in fee, even though the actual value is practically the same, that the owner may deduct the depletion as of March 1, 1913, but that the lessee is restricted to the actual amount put in there, and it is that particular point that seems to me to result in inequity. Mr. MOORE. Will you state that in some concrete way?

Mr. KELLY. Perhaps I might give an example. Let us take the case of a corporation that would acquire 1,000 acres of land, and take that acquisition as of 1910. By the expenditure of, perhaps, $50,000 that corporation might be lucky enough to bring in wells making the property worth $200,000. If that corporation is a lessee there is no deduction or no amount upon which it can ever claim depletion, yet if at the outset instead of taking a lease it had paid, perhaps, $1 or $2 more per acre, and had expended, perhaps, $2,000 more, it would be in the status of an owner and could set up that $200,000 valuation as of March 1, 1913. In other words, in the case of the owner they make an allowance for the I do not know whether you would term it the unearned increment or the actual wealth which has been created by reason of their operations, but in the case of the owner they make an allowance which is perfectly proper. But the average oil lessee-and I may say that 90 per cent of the operations are carried on by lessees, there are very few owners

Mr. MOORE (interposing). How has your concern been drawn into this?

Mr. KELLY. In this way: That in making up our return this last year we have made the claim that under the particular Government regulations our status is practically that of the owner, and that, therefore, we should have an allowance for depletion.

Mr. MOORE. Has the department made a ruling that you shall not have such a deduction?

Mr. KELLY. They have not ruled specifically, no.

Mr. MOORE. Is there any ruling on the part of the department which leads you to believe that will be the result?

Mr. KELLY. Only this general ruling which says that in the case of everyone except the owner in fee a deduction will not be allowed. In other words, they seem to attach some magic to the words "owner in fee" even though that does not comprehend any more, so far as the oil industry goes, than a perpetual lessee.

Mr. MOORE. Take the language you have quoted from the act of September 8, 1916. What changes would you recommend?

Mr. KELLY. I should think that some appropriate language placed in the second clause, beginning with the word "provided," would cover it. Instead of saying in case of purchases made prior to March 1, 1913, I would have some such words as "purchase, lease or other acquisition." I do not know the exact language, but some appropriate language which would cause the perpetual lessee to receive this allowance.

The CHAIRMAN. Just add the words "or acquire" after the word "purchase."

Mr. OLDFIELD. Your desire is to put the owner and the lessee on the same footing?

Mr. KELLY. Yes, sir. Of course, so far as the actual value of those interests are concerned, they will always be slightly different, because the owner does not have to pay his one-eighth royalty to anyone.

Mr. MOORE. Your fear is that while you are the lessee you may be held as a purchaser; is that the point?

Mr. KELLY. No; quite the opposite. I am afraid they will not consider us as a purchaser and will not allow us the deductions. My fear is that we will be held merely to be lessees and will not be allowed the deduction.

Mr. HAWLEY. How much difference would it make to you in money if your status were that of an owner instead of that of a lessee?

Mr. KELLY. That is a rather hard question to answer, because the appraisal of the properties as of March 1, 1913, is subject to the approval of the Secretary of the Treasury, and that will be dependent on the value which he puts on them.

The CHAIRMAN. Do you buy these leases outright or do you pay so much a year? Say you have a lease for 10 years; do you pay so much a year?

Mr. KELLY. We pay a one-sixth royalty on the holdings which we have in the Osage Nation, to the superintendent of the Osage agency for the benefit of the tribe, and in the case of the other leases, we 'simply remit to the lessor, at stated intervals, one-eighth of the gross production as his royalty.

The CHAIRMAN. Were these leases to which you are referring now made prior to March 1, 1913?

Mr. KELLY. They were not made prior to March 1, 1913; they were actually executed on March 16, 1916, but that was a situation which grew out of prior operations. The Department of the Interior said, in effect, to the lessees who had previously been operating there that the leases which expired on March 1, 1916, should be given to them in the shape of new leases, and that was done.

The CHAIRMAN. They all had notice that after March 1, 1913, an income tax was constitutional and that in all probability one would be passed, and March 1, 1913, was put in because a person might have purchased property long before there was any constitutional power in Congress to levy an income tax. Take lumber, for instance. A person might have purchased lumber at 50 cents a thousand in 1899 and 1900, and on March 1, 1913, it had appreciated in value to $5. They had no right to put an income tax on that appreciation before March 1, 1913, because there was no constitutional power to levy any income tax. So the committee provided that they could take the fair valuation of the property, say of lumber, oil, or coal, as of March 1, 1913, when Congress did have the right to levy an income

tax.

Mr. KELLY. The intent being to fix a fair valuation on the capital existing as of that time.

The CHAIRMAN. Yes. I want to ask you a question for my own. information. About what is the average length of time, after you strike oil, that you can continue the operation of a well?

Mr. KELLY. That depends entirely on the field and it is dependent upon so many natural conditions, the depth of the well, the thickness and texture of the sand, and the amount of gas.

The CHAIRMAN. Some last as long as 1 year, some 3 years, and some 10 years.

Mr. KELLY. Yes; and there are some wells in Pennsylvania that have been in operation for 25 years.

The CHAIRMAN. What do you think about the average life of new wells now-wells that have been developed in the last four or five years?

Mr. KELLY. That, again, is dependent on the field.

The CHAIRMAN. Would you say it would be three years or a good deal more?

Mr. KELLY. I should say it would be more than that.

The CHAIRMAN. A committee of oil men told me it was three years. Mr. KELLY. That may have been true of their particular localities. The CHAIRMAN. They represented oil wells in Oklahoma and Illinois, as well as other States. I just wanted to get your best judg

ment.

Mr. KELLY. I was just speaking of the general average.

The CHAIRMAN. But there is really no way you can get at the general average, is there?

Mr. KELLY. No, there is not; although after a field has been proven and in operation for a considerable number of years you can then approximate it, and you can come near enough, perhaps, to do substantial justice for tax purposes in computing depletion, but it is a very difficult situation to compute depletion properly so that the Government will get sufficient revenue and at the same time the producer have a reasonable allowance.

The CHAIRMAN. The real question is the allowance to be granted? Mr. KELLY. Yes, sir. We feel that under present conditions there is no allowance, because, again, we are in this situation: The oil producer must take the greater part of his earnings every year and put them back into the ground, because as his old wells decline he must drill new wells in order to keep his production stationary. Now, there comes a point after he gets his property pretty well drilled up, that in spite of everything he does he can not keep his production stationary, and it is going to continue to go down. It is not like a steel mill. If you take the greater part of your profits and reinvest them in your steel mill, at the end of 15 years you probably have a big business; but that is not the case with the oil business. You are through; there is no more oil under there, and therefore you must have made enough to pay back the initial investment, the reinvestments you have made, plus a reasonable profit.

The CHAIRMAN. As a matter of fact, in the oil business you get rich mighty quick or poor mighty quick.

Mr. KELLY. That is just about what it sums up to; yes.

Mr. WHITE. How many wells has your company?
Mr. KELLY. I should say in operation about 180,

Mr. WHITE. And you have a 1,200-barrel capacity?

Mr. KELLY. Yes, sir. That, of course, is entirely approximate, because sometimes it might be a little less or a little more. Mr. WHITE. Is that gross?

Mr. KELLY. That is net.

Mr. WHITE. Are you continuing your drilling operations?
Mr. KELLY. Yes, sir; we are very active on that.

Mr. WHITE. You could not tell us what your falling off in production has been?

Mr. KELLY. No.

Mr. WHITE. You could as to your old wells, could you not?

Mr. KELLY. Yes; although from a practical standpoint it is sometimes difficult to do that, because that comes in again under Treasury Decision 2047, where the department laid down certain rules for the computation of depletion. If you had one well that ran into one tank, so that you could gauge that tank from time to time and see what that well did, it would be practicable to keep a check on it, but you frequently have a number of wells.

Mr. WHITE. You mean that you would have a new well running into an old tank?

Mr. KELLY. Perhaps it would be a well that had been in operation for some time, or a number of old wells, running into the same tank. It is not practicable from the operating standpoint to separate them.

Mr. HULL. On this question as to whom particular allowances for depletion should go, whether to the lessor or the lessee, the courts have been holding that the person who leases land for mineral purposes does not acquire any rights to the minerals in place, as they call it, but that the legal title to the minerals in place, so far as these allowances are concerned, remains in the person who leased the land.

Mr. KELLY. I believe that probably is true with respect to solid minerals, although I believe there was a decision handed down by the Supreme Court of the United States within the last few weeks construing the act of 1909, and, as I recall the decision, they reaffirmed the proposition that there could be no allowance for depletion under the act of 1909. At the same time they discussed at some length the relative interests. But, as you can see, that is the very point of the oil business. Neither the owner or the lessee can get any title to any specific oil in place until he finds it out.

Mr. HULL. That is what I am speaking of. You want legislation to relieve against a practice, and to some extent against the law, or you want relief on account of some court decisions under the present wording of the law.

Mr. KELLY. I think that would probably cover it; yes, sir. If you dealt with abstractions and called this estate of the lessee some intangible thing, you would not get anywhere, but you should look at it from the practical standpoint and see what the lessee in such cases is dealing with. If a man comes to purchase your property, he might give you just as much, with the exception of the royalty interest, for a lease, as long as oil and gas are produced, as he would for the fee.

Mr. HULL. There has been some conflict in the department and in some of the decisions with reference to certain classes of miners. There has been some conflict between their holdings.

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