Under the provisions of the timber contract in question, the income derived by the lessee is ordinary income within the scope of the tax laws of the State of Georgia.
The State Revenue Commissioner, hereinafter called the Commissioner, proposed an additional assessment of Georgia taxes against the Superior Pine Products Company, hereinafter called the defendant. The tax and interest assessed were as follows:
"Year Additional Tax Interest Total 1952 $11,753.53 $1,351.66 $13,105.19 1953 10,726.46 589.96 11,316.42 ---------- --------- ---------- Totals $22,479.99 $1,941.62 $24,421.61" The defendant filed a written protest against the proposed assessment, submitted a written brief in support thereof, and was heard orally by the Commissioner thereon. The protest was denied and the proposed assessment was made final by the Commissioner. The defendant filed an appeal from the ruling of the Commissioner to the Superior Court of Chatham County. Jury trial was waived by agreement of counsel and the case was heard by a judge on agreed facts and stipulations which we will set forth hereinafter. Counsel agreed that the controlling issue was whether or not, for the years involved, certain receipts received by the defendant from the St. Regis Paper Company, pursuant to a contract between these parties, constituted proceeds from the sale of capital assets, as returned by the defendant, or ordinary income as assessed by the Commissioner. All stipulations, as set forth in the bill of exceptions read as follows: "The parties to the above styled case, by and through their respective attorneys, stipulate as follows: This case is before the Superior Court of Chatham County, Georgia, on appeal from rulings of the Revenue Commissioner with respect to the State of Georgia income tax returns filed by Superior Pine Products Company for the years 1952 and 1953. Most of the income which gives rise to the controversy was received during the years in question by the taxpayer, Superior Pine Products Company, from St. Regis Paper Company pursuant to a contract between those two companies entered into on August 27, 1947, a copy of which contract (excluding the description of the lands involved) is hereto attached and made a part of these stipulations.
"The timber lands which constitute the subject matter of the contract were acquired by the taxpayer more than twenty years ago, and for a number of years were utilized by the taxpayer for the production of gum naval stores (turpentine and rosin). At the time the lands were acquired, the taxpayer's principal stockholders were engaged in a chemical manufacturing business in which a considerable quantity of gum was used, and one of the purposes of investing in these timber lands was to assure the chemical business of a continuing supply of rosin. Prior to 1947 the chemical business had been liquidated and it had been increasingly difficult to procure labor for large scale turpentine operations. The taxpayer had ceased to carry on its own naval stores operations upon the lands, and had leased its turpentine timber to other operators. The movement of the kraft paper industry to the Southeast had also created a ready market for pine timber for pulpwood purposes. These developments led to the making of the contract with St. Regis Paper Company.
"While the taxpayer was engaged in the turpentine business, and thereafter while leasing its turpentine timber to others, the taxpayer, from time to time, did salvage the pine trees which had been worked out for turpentine purposes by selling them to sawmill companies and pulpwood producers. Similarly the taxpayer, from time to time, sold such hardwood timber as grew upon the swampy portions of its lands and the pine timber which was unsuited for turpentine purposes. Since 1932 the taxpayer has never cut and logged any of its timber, but has sold it as standing timber to be logged by the purchasers. The taxpayer never bought timber for resale and never engaged in the business of selling standing timber unless the sales mentioned above amount to engaging in such business.
"The lands affected by the contract constitute all of the real property owned by the taxpayer except a small tract of timber land located several miles from the other timber lands of the taxpayer, and except several houses and town lots in the town of Fargo, Georgia. Other than the sales to St. Regis Paper Company under and pursuant to the said contract, the taxpayer has sold no timber since 1947 except one sale in 1951 of standing timber marked and sold from the small tract mentioned above in order to thin the stand of timber on that tract of land from which sale the taxpayer received $8,127.09 in the year 1952, and except a sale of a few shade trees thinned from the Fargo town property in 1953 which netted the sum of $93.16.
"The receipts from St. Regis Paper Company of the purchase price of timber sold under and pursuant to the contract amounted to $413,835 in 1952 and to $408,285 in 1953.
"In making and filing its income tax returns for the years 1952 and 1953, the taxpayer treated all of the above mentioned receipts from sales of timber as receipts from the sale of capital assets held for more than six months, claiming the benefits of Sections 92-3119 (d) and 92-3122 of the Code of Georgia, Annotated. The Commissioner of Revenue has denied that the taxpayer is entitled to long term capital gains treatment of these receipts and has insisted that the receipts are taxable to their full extent as ordinary income.
"Accordingly the Commissioner caused to be sent to the taxpayer on January 25, 1955, his usual 30-day notice of a proposed deficiency assessment for the years 1952 and 1953. In response to that notice the taxpayer duly filed its protest and petition for redetermination of the deficiency. After a hearing was had the Commissioner on April 21, 1955, notified the taxpayer of his ruling against the protest and denying any redetermination of deficiency. From that ruling the taxpayer filed its appeal to the Superior Court of Chatham County. On May 11, 1955, the Commissioner made a deficiency assessment against the taxpayer with respect to the years 1952 and 1953 in amounts aggregating $24,758.00 principal and interest, and notified the taxpayer of the assessment. The taxpayer thereupon filed a timely appeal from that assessment to the Superior Court of Chatham County. The parties stipulate that the said two appeals be consolidated for the purposes of this case and be heard by the court as one case.
"The taxpayer, Superior Pine Products Company, is a corporation organized and existing under the laws of the State of Georgia and chartered by order of the Superior Court of Chatham County, Georgia. Its president is its only full time employee. He lives at Fargo, Georgia, and his duties consist principally of keeping in touch with the operations of St. Regis Paper Company under the contract of August 27, 1947, and seeing that the timber is cut and the forest is protected and preserved in the manner required by that contract. The taxpayer's secretary and treasurer draws a salary for his part-time work of keeping the company's records and handling its fiscal affairs. The taxpayer has no other employees.
"Taxpayer is the owner of real property in Georgia the value of which is in excess of the amount of the taxes in dispute in this case.
"Jury trial is expressly waived."
The parts of the contract of August 27, 1947, between Superior Pine Products Company and St. Regis Paper Company, referred to above, which are material to the consideration of the questions involved in this appeal are hereinafter stated in the exact language of the contract or in substance:
"This indenture, made, executed and delivered in duplicate, this 27th day of August, 1947, by and between Superior Pine Products Company, a corporation organized and existing under the laws of the State of Georgia, having its principal office at Fargo, Georgia, hereinafter called `Seller', and St. Regis Paper Company, a corporation organized under the laws of the State of New York, having its principal office at 230 Park Avenue, New York, N. Y., hereinafter called `Purchaser', witnesseth:
"That for and in consideration of the sum of $10.00, and in consideration of the mutual covenants and agreements herein contained, it is agreed between the parties hereto as follows: 1. Seller hereby agrees to sell to purchaser, and purchaser agrees to buy from seller, during the term beginning January 1, 1948, and continuing until December 31, 2007, unless sooner terminated, as hereinafter provided, all timber and timber rights hereinafter more specifically set out, growing and to be grown, on the land described in Exhibit `A' hereto attached and made a part hereof, containing two hundred eight thousand acres, more or less, upon the terms and conditions hereinafter set out.
"2. Purchaser shall buy, cut and remove or otherwise utilize said timber in the amounts hereinafter more specifically set out during each year of the term of this agreement. Purchaser shall, subject to the provisions hereinafter contained, pay to seller as the purchase price of the timber bought, cut and removed or otherwise utilized hereunder, the sum of $2.00 per cord of pulpwood or its equivalent; provided, however, that if the average of wholesale commodity prices as determined and reported by Fisher's Index of Wholesale Commodity Prices for any calendar year shall be greater or less than the level of said index of 133.0 as of August 31, 1946, by as much as or more than five percent, then the purchase price of such timber bought, cut removed or otherwise utilized by purchaser during such calendar year and the payments required by paragraph 4 hereof on account of such year shall be adjusted by the percentage that such average for such year is more or less than the level of said index of 133.0 as of August 31, 1946, except that the total sum payable by purchaser to seller under this agreement on account of any calendar year shall not in any event be less than $150,000.00. . .
"4. In the best judgment of the parties hereto, under normal conditions, and good forestry practice, the acreage involved will have an average annual growth or reproduction of at least 150,000 cords. On January 1, 1948, and on the first day of each quarter thereafter during the entire term of this agreement, purchaser shall pay to seller a sum equal to one-fourth of the purchase price of 150,000 cords of pulpwood, or its equivalent. Such quarterly payments shall be based upon the price of $2.00 per cord of pulpwood or its equivalent, until a different price per cord of pulpwood or its equivalent is fixed in accordance with the provisions of paragraph 2 hereof; and after a different price per cord of pulpwood or its equivalent is so fixed, such quarterly payments shall be based upon the most recent price per cord of pulpwood or its equivalent so fixed; and such quarterly payments shall also be subject to adjustment after the end of the year with respect to which they are made in accordance with the provisions of paragraph 2 hereof. Should purchaser during any one or more calendar years not cut, remove or otherwise utilize timber in the amount purchaser is required to pay for with respect to such year, then purchaser shall be entitled to cut, remove or otherwise utilize, during subsequent years, the timber so paid for but not cut and removed, or otherwise utilized in prior years; provided, that the purchaser shall not be entitled to cut, remove or otherwise utilize timber during any current year applying the same against its credit created by payments in prior years until purchaser shall have cut, removed or otherwise utilized the allowable cut for such current year, as provided and fixed by the provisions of paragraph 5 hereof. If purchaser does not, prior to the expiration or termination of this agreement and within twelve years after the year with respect to which such timber is paid for, cut, remove or otherwise utilize the same, then the right of purchaser to cut, remove or otherwise utilize the timber so paid for shall terminate and such excess payment shall be retained by seller as liquidated damages for purchaser's failure to cut or utilize said timber in accordance with the terms of this agreement, and thereafter purchaser shall have no right to cut and remove or otherwise utilize additional timber to apply thereon.
"5. Purchaser shall have the right to cut and remove and otherwise utilize up to 150,000 cords of pulpwood or its equivalent during each calendar year of the term of this agreement, provided that said amount shall be subject to increase or decrease, as herein provided. Should the average growth or reproduction of the timber upon said lands fall below 150,000 cords of pulpwood or its equivalent then the amount which purchaser shall have the right to cut and remove or otherwise utilize shall be reduced to the amount of such average annual growth or reproduction; but the amounts which purchaser shall be required to pay under paragraph 4 hereof shall not be reduced. Should the average annual growth or reproduction of the timber upon said lands exceed 150,000 cords of pulpwood or its equivalent, then purchaser shall have the right annually to cut and remove or otherwise utilize timber in an amount equal to such average annual growth (including such excess); and purchaser shall pay for such average annual growth (including such excess), at the price and in the manner prescribed in paragraphs 2 and 4 hereof (whether the same is cut, removed or otherwise utilized or not), by correspondingly increasing the payments provided for in paragraph 4 hereof so that such payments shall annually equal the purchase price of said entire average annual growth or reproduction. Purchaser shall furnish seller, before the beginning of each calendar year, a copy of its plan for such year's operation, and shall conform to such plans to the extent circumstances permit, and shall give written notice to seller of any substantial changes in or departures from such plans. Said plans or any changes therein or departures therefrom shall not, however, operate as amending or modifying the terms of this agreement. Seller shall have access to the land for any and all purposes not inconsistent with the terms and provisions of this agreement."
Paragraph 5(a) provides that the purchaser would at its own expense at all times during the term of the agreement, manage and operate said farm lands and the timber thereon in accordance with good forestry practice from time to time prevailing, including, but not limited to, the restocking of areas cut or burned, and with such fire protection as good forestry practice required in such manner that the average annual growth or reproduction should not be less than the amount of timber cut and removed or otherwise utilized annually. This paragraph also defined good forestry practices and provided what logging operations might be utilized. It also provided that the purchaser would restock or plant any areas "clear cut" or so damaged by fire as to kill substantially all existing timber growth leaving thereon less than five seed trees per acre and any area operated under the seed tree plan, if said area has not been naturally restocked by seedlings within two years after the first seed crop occurring subsequently to the cutting operations and that in areas required to be restocked not less than 400 trees per acre should be planted by the purchaser.
Paragraph 6 provided for arbitration in case of dispute between the parties as to matters mentioned therein.
Paragraph 7 provided for contingencies resulting from certain damage by fire to any part of the lands totaling 500 acres or more.
Paragraph 9 provided for certain costs and taxes.
Paragraph 10 provided for the right of the purchaser to use, occupy and repair all existing improvements, buildings and structures upon the land with a certain exception and provided that at the expiration of the agreement the purchaser should return the buildings and improvements in as good condition as when received, ordinary wear and tear excepted.
Paragraph 17 provided that the title to timber shall pass from seller to purchaser when and only when such timber is severed from the land.
Paragraph 24 provided that the agreement should be construed in accordance with the laws of the State of Georgia.
It was also in evidence before said court that the charter of said Superior Pine Products Company showed that it was a profit-making corporation, authorized, among other things, "(b) To farm, cultivate, manage, clear, plant, drain, build on, reforest or otherwise improve and develop all or any of the lands and properties of the company. . . (c) To cut down, carry away, prepare and sell timber on the lands of the company. . . (g) To carry on the several businesses of farmers, graziers, raisers of livestock, lumber men, miners, manufactures, dealers and traders in lumber and wood, minerals of all kinds, and other products and any other substances, and to carry on any trade or business and to vend articles and effects of every description and generally to act as agriculturalists . . ."
The judge rendered an opinion and entered final judgment sustaining the appeal of the defendant, thus reversing the assessment of the Commissioner, and the court directed an assessment in accordance with the appeal of the defendant. It is the contention of the defendant that the amounts involved were gains from the sale of capital assets held for more than six months. This the Commissioner denies and has determined in his assessment that such amounts are taxable as ordinary income. It follows that if the defendant is correct, the assessment is improper and the judgment of the court should be affirmed and on the other hand, if the Commissioner is correct, the assessment is proper and the judgment of the Superior Court of Chatham County should be reversed and the assessment made final.
GARDNER, Presiding Judge.
The defendant relies on Code (Ann.) § 92-3119 (d) which reads as follows: "There shall be included in `gross income' of a taxpayer, as defined in § 92-3107, gains from the sale or exchange of `capital assets', as hereinafter defined, and in the deductions, of a taxpayer, as defined in § 92-3109 (d) . . . (1) (A) The term `capital assets' means property held by the taxpayer (whether or not connected with his trade or business) but does not include — 1. Stock in trade . . . or property held . . . primarily for sale to customers in the ordinary course of his trade or business; 2. Property, used in his trade or business, of a character which is subject to the allowance for depreciation provided in § 92-3109 (f), or real property used in his trade or business."
The defendant also relies on Code (Ann.) § 92-3119 (d) (1) (K) (2) which reads as follows: "Percentage taken into account. — In the case of a taxpayer, if for any taxable year the net long-term capital gain exceeds the net short-term capital loss, 50 percent of the amount of such excess shall be a deduction from gross income."
Code (Ann.) § 92-3122 reads: "The executive order of the Governor, dated May 20, 1952, as amended January 6, 1953, suspending the collection of income tax on corporations which is due by a failure to provide corporations the deduction from gross income of 50 percent of the excess of net long term capital gain over a net short term capital loss as is provided an individual, required to be paid under the Georgia Income Tax Act as amended by Georgia Laws approved February 15, 1952, is hereby ratified, approved and confirmed. All corporation income taxes which have accrued under said Act as amended since February 15, 1952, or may hereafter accrue by failure to provide the same deduction for a corporation as is provided for an individual as provided in said order of the Governor and while said order is effective and/or during the regular session of the General Assembly in 1953, are hereby remitted, cancelled and annulled."
The defendant relies also on Code (Ann.) § 92-3119 (g) which reads as follows: "In the case of a sale or exchange of `other assets' used in a trade or business, the following rule shall apply . . . (2) In the case of a gain and the property used in the trade or business has been held longer than six months, only 50 percent of the gain shall be taken into account."
The determination of whether the income here involved is regular income or capital gain depends not on the interpretation of the law but on the interpretation of the contract. Is the intention of the parties to sell and buy capital assets of the seller or is the intention to lease the land for sixty years for the purpose of pine-tree farming by the tenant? We think that the answer is unquestionably the latter. The criterion in ascertaining intent here is whether as a result of the activities of the tenant the capital assets of the owner or seller are depleted by the tenant in the course of its performance of the contract. The terms of the contract show without question that the assets, principally pine trees fit for pulpwood purposes, are not to be depleted but replaced and replacements nurtured through the years so that at the end of the term of the lease the status of the lands insofar as pulpwood trees are concerned would not be materially different from their status at the time of the contract. The Federal cases cited which involve the selling off of trees, without provisions for replacement over a period of years are so clearly distinguishable from this case that further discussion is unnecessary. The Federal cases most similar to this one hold the income to be regular income and these cases are not as strong on their facts in favor of regular income as the facts in this case because the element of continuous replacement and resupply of capital assets is not present in those cases. The cases referred to are: Burnet v. Harmel, 287 U.S. 103, 106 ( 53 Sup. Ct. 74, 77 L. ed. 199); Albritton v. Commissioner, 24 T.C. 903. The fact that the rental is based, over and beyond a minimum rental, on the number of cords of wood cut, is not controlling. The gravamen of the issue is whether capital assets are depleted. We think that the intention is that they should not be. The fact that Section 117 (k) of the Federal Internal Revenue Code of 1939 was not enacted as the law of Georgia is immaterial so far as this case is concerned. It reads in part as follows: "In the case of the disposal of timber or coal (including lignite), held for more than six months prior to such disposal, by the owner thereof under any form or type of contract by virtue of which the owner retains an economic interest in such timber or coal, the difference between the amount received for such timber or coal and the adjusted depletion basis thereof shall be considered as though it were a gain or loss, as the case may be, upon the sale of such timber or coal . . ." This section was not intended to refer to a lease such as we have in this case, but was to remove inequities existing because of situations which arose in an owner's selling off of timber, where there was no provision for farming timberlands or replacing depleted lands. Insofar as this case is concerned the law would be the same if Section 117 (k) of the Federal Internal Revenue Code was included in the Georgia law. We agree with the taxpayer's argument on this point. There may be one or two more reasons why the income involved is regular income, but what we have said above is sufficient, it being in our opinion the most compelling reason for our conclusion.
The court erred in reversing the judgment of the Commissioner.
Judgment reversed. Felton, C. J., Carlisle, Quillian and Nichols, JJ., concur. Townsend, J., dissents.