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Legal Ruling No. 203

September 17, 1957


Oil royalty payments made to nonresidents from California properties are taxable as income from sources within this state.

Taxpayers are nonresidents of California. They received oil royalties from an oil company to which they had given an option to purchase certain federal oil and gas leases on California property. During the option period the oil company had the right to explore for oil on the leased land, with an overriding royalty of 5% having been retained by the taxpayers. Advice has been requested as to whether the payments to the taxpayer constitute income from a source within this state and are constitutionally taxable.

According to Fed. Rul. GCM 27322 CB 1952-2, 62 and the cases of Burnett v Harmel, 287 US 103 and Palmer v Bender, 287 US 551, the payments here in question are considered to be in the nature of advance royalties. The taxability of the royalties to nonresidents depend therefore on the nature of the ownership which produced them. The more recent cases which have considered the problem have held that if the lease is for a term of years and as long thereafter as oil and gas are produced, the interest acquired is a profit a prende in gross, which is a freehold interest in real property. Even where the lease is for a definite period of time, it still represents an interest in real property for taxation purposes. Delaney v Lowery, 25 Cal 2d 561 and Appeal of The Petroleum Company, State Board of Equalization, April 20, 1932. An economic interest in oil in place amounts to actual ownership and any taxpayer entitled to a depletion deduction has an interest in real property. IT 3693 CB 1944, pg. 272.   For these reasons it is concluded that royalties from oil and gas properties in California have their source within this state and, consequently, are taxable to nonresidents.

Where a lease on governmental land is acquired by a private individual, the income therefrom is not immune from taxation on the basis that there is an interference with the function of government, Helvering v Mountain Producers Corp, 303 US 376. Interference, if at all, is too remote and indirect to require exemption. Consequently, there is no constitutional bar to taxing the above payments.

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