During the calendar year 1926 the petitioner was appointed by the President of the United States, by and with the advice and consent of the Senate, an associate justice of the Supreme Court of the Territory of Hawaii, and duly qualified for and entered upon the duties of that office during October 1926. The petitioner was reappointed to that office on February 23, 1931, and duly qualified under the reappointment on March 11, 1931.

During the period March 11, 1931, to August 17, 1935, the petitioner performed the duties of his office and received from the Federal Government a salary of $10,000 per annum set therefor by Act of May 29, 1928, chapter 904, sections 1 and 2, 45 Stat. 997, except that during the effective period of the Economy Act of June 30, 1932, chapter 314, 47 Stat. 382, 401, as amended, which began July 1, 1932, and ended March 31, 1935, percentage deductions were made from the petitioner's fixed salary.

The amounts of salary actually received by the petitioner from the Treasurer of the United States during the years 1934 and 1935 for services performed as an associate justice were $9,208.32 in 1934 and $6,152.77 in 1935.

The petitioner duly filed with the collector at Honolulu returns of annual net income for the calendar years 1934 and 1935 and included therein as items of gross income, and also as deductions, the above stated amounts of $9,208.32 and $6,152.77, respectively.

The respondent in his determination of the deficiencies herein for the calendar years 1934 and 1935 included the said amounts of $9,208.32 and $6,152.77 in petitioner's gross income, but disallowed their deduction. The deficiencies herein result entirely from such adjustments.

The only issue in this proceeding is whether the salary received by the petitioner as an associate justice of the Supreme Court of the Territory of Hawaii during the years 1934 and 1935 is subject to income tax.

In his income tax returns for 1934 and 1935 the petitioner included his salary in gross income but deducted it from the gross income in determining net income. The respondent restored it to net income in the determination of the deficiencies involved herein, stating in his deficiency notice, which forms the basis for this proceeding:

Salary received as associate justice of the Supreme Court of the Territory of Hawaii, is held by this office to be taxable income since Justices of the Supreme Court of the Territory of Hawaii are not judges of inferior courts of the United States within the meaning of article III, section 1, of the United States Constitution.

The petitioner submits that his salary is exempt from Federal income tax in accordance with paragraph 3 of section 80 of the Organic Act of the Territory of Hawaii, which provides:

The salaries of all officers other than those appointed by the President shall be as provided by the legislature, but those of the chief justice and the justices

of the supreme court and judges of the circuit courts shall not be diminished during their term of office.

He submits that this provision of the organic act is traceable through mesne enactments to Article III, section 1, of the Constitution of the United States, which provides:

The Judicial Power of the United States shall be vested in one Supreme Court and in such inferior courts as the Congress may from time to time ordain and establish. The Judges, both of the Supreme and inferior courts shall hold their offices during good behavior, and shall, at stated times, receive for their services, a compensation which shall not be diminished during their continuance in office. He further submits that the courts of Hawaii, following opinions of the Supreme Court of the United States (Pollock v. Farmers' Loan & Trust Co., 157 U. S. 429; Evans v. Gore, 253 U. S. 245; and Miles v. Graham, 268 U. S. 501), have held, in Robertson v. Pratt and Waimea Sugar Co. v. Pratt, 13 Hawaii, 590; and Frear v. Wilder, 25 Hawaii, 603, 607, that the salaries of the judges of the Supreme Court of the Territory of Hawaii are not subject to the Hawaiian income tax, upon the ground that such a tax would operate to diminish their compensation within the purview of paragraph 3 of section 80 of the Organic Act of the Territory of Hawaii; that this was the law governing the issue herein presented at the time the petitioner received his salary in 1934 and 1935. He further submits that the respondent has not subjected to Federal income tax the salaries of the justices of the Supreme Court of the Territory of Hawaii received prior to 1934.

In O'Malley v. Woodrough, 307 U. S. 277, decided May 22, 1939, the Supreme Court had before it the question as to whether the salary of a judge of one of the United States Circuit Courts of Appeal was subject to income tax under section 22 (a) of the Revenue Act of 1934, which provides in part:

In the case of Presidents of the United States and judges of courts of the United States taking office after June 6, 1932, the compensation received as such shall be included in gross income; and all Acts fixing the compensation of such Presidents and judges are hereby amended accordingly.

In its opinion the Supreme Court held that the salary of the judge in question, who had entered upon the duties of office after June 6, 1932, was subject to income tax, saying:

Congress has committed itself to the position that a non-discriminatory tax laid generally on net income, is not, when applied to the income of a federal judge, a diminution of his salary within the prohibition of Article III, §1 of the Constitution.

The facts in the instant case are that the petitioner entered upon the duties of his office prior to June 6, 1932. It is therefore argued that the salary received by him in 1934 and 1935 is exempt from income tax.

It is not necessary in this proceeding to determine whether the salary of a judge of a constitutional court entering upon the duties of his

office prior to June 6, 1932, is subject to income tax in 1933 and 1934. We have not that question before us.

The Supreme Court of the Territory of Hawaii is not a "constitutional" court within the meaning of Article III, section 1, of the Constitution. It is a "legislative" court created under Article IV, section 3, clause 2 of the Constitution, which vests in Congress the power to "dispose of and make all needful rules and regulations respecting the territory or other property belonging to the United States." See O'Donoghue v. United States, 289 U. S. 516. Congress clearly has the power under that provision of the Constitution to make any changes which it desires with respect to the terms of office or the salary of justices of a legislative court. It may diminish their compensation if it chooses to do so.

It is furthermore to be noted that the petitioner's compensation for the years 1933, 1934, and 1935 was reduced by the Economy Act of June 30, 1932, chapter 314; 47 Stat. 382, 401, as amended. That act expressly exempted from its provisions "(* * judges whose compensation may not, under Constitution, be diminished during their continuance in office)." The petitioner's compensation was diminished under the provisions of that act because the diminution thereof was not prohibited by the Constitution of the United States.

Charles F. Hatfield, 38 B. T. A. 245, involved the question whether the salary of a judge of the United States Court of Customs and Patent Appeals was subject to income tax for the years 1934 and 1935. There, as here, the judge entered upon the duties of his office prior to June 6, 1932. There, as here, the judge was a member of a legislative court and not of a constitutional court, within the meaning of Article III, section 1, of the Constitution of the United States. We held that his salary was subject to income tax. All that we said there is equally applicable here. Upon the theory of that case it must be held that the salary of the petitioner received as an associate justice of the Supreme Court of the Territory of Hawaii during the years 1934 and 1935 is subject to income tax.

Decision will be entered for the respondent.

GRISON OIL CORPORATION, PETITIONER, V. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 96132 Promulgated October 30, 1940.

In determining the 50 percent limitation on percentage depletion
allowable under section 114 (b) (3), Revenue Act of 1936, amounts
of income tax paid to the State of Oklahoma must be deducted in
computing net income from the property, where such state tax was
based wholly on income derived from such property.

Chas. H. Garnett, Esq., for the petitioner.
J. E. Marshall, Esq., for the respondent.

Respondent determined a deficiency of $109.22 in income tax for the year 1936, as the result of his action in deducting income tax paid to the State of Oklahoma in arriving at net income for the limitation of percentage depletion. Whether or not respondent erred in deducting such tax is the sole issue submitted for decision. The facts were stipulated by the parties.

FINDINGS OF FACT.

Petitioner is a corporation organized under the laws of the State of Oklahoma in 1931, having its principal office and place of business at Oklahoma City, Oklahoma. Its business is the production and sale of crude oil. Petitioner keeps its books of account and makes its returns on the accrual basis. Its corporation income and excess profits tax return for the calendar year 1936 was filed with the collector at Oklahoma City.

Prior to 1935 petitioner acquired an oil and gas property in the County of Oklahoma, State of Oklahoma, designated as the Turner lease. Petitioner operated this property, producing and selling oil therefrom; and it carried on no other business in 1936. Its gross income from the property in 1936 was $113,684.38.

Income taxes due the State of Oklahoma for the year 1936 were accrued by the petitioner in the amount of $1,777.46 in 1936; and income taxes for the year 1933 in the amount of $43.76 were paid by the petitioner to the State of Oklahoma in 1936.

Respondent, for the purpose of applying the 50 percent limitation upon petitioner's depletion allowance, determined petitioner's net income from the property for the year 1936 was $55,828.32, and fixed its depletion allowance at one-half thereof, or $27,914.16. In determining the net income of $55,828.32, respondent deducted from gross income, among other things, the aforesaid Oklahoma income taxes, amounting in all to $1,816.30.

In the deficiency notice and pleadings in this proceeding, the sum of $3,132.89 has been erroneously treated as the amount of Oklahoma income taxes. The correct amount is $1,816.30, as hereinabove stated. The difference between $3,132.89 and $1,816.30 represents other taxes as to which there is no dispute.

Petitioner contends that the action of the respondent in deducting Oklahoma income taxes amounting to $1,816.30 from its gross income in determining its net income, for the purpose of applying the 50 percent limitation upon its depletion allowance, was erroneous; and that its depletion allowance for 1936 should be $28,822.31.

OPINION.

HILL: The question before us in this case is whether or not respondent erred in deducting from gross income the amounts of income tax paid by petitioner to the State of Oklahoma, in order to determine the net income from petitioner's oil property for depletion purposes, pursuant to section 114 (b) (3) of the Revenue Act of 1936. The statute provides that in the case of oil and gas wells the allowance for depletion shall be 272 percent of the gross income from the property, but that such allowance shall not exceed 50 percent of the net income of the taxpayer (computed without allowance for depletion) from the property.

Article 23 (m)-1 (h) of respondent's Regulations 94, issued under the above statute, defines "net income of the taxpayer (computed without allowance for depletion) from the property" as meaning the gross income from the property, less the allowable deductions attributable to the mineral property upon which depletion is claimed, "including overhead and operating expense, development costs properly charged to expense, depreciation, taxes, losses sustained, etc., but excluding any allowance for depletion."

On brief petitioner argues that the state income tax should not be deducted from gross income in computing net income from the property, for the purpose of applying the 50 percent limitation on the depletion allowance, for the reason that such tax is wholly unrelated to the production of income from its oil property, and that a fair interpretation of the word "taxes" as used in respondent's regulations does not embrace such a tax.

We are unable to agree with this theory. The Oklahoma income tax would appear to be an allowable deduction attributable to the mineral property upon which depletion is claimed, since the amount is an allowable deduction in computing taxable net income under the Federal taxing act, and the parties have stipulated that during the taxable year petitioner was engaged in operating an oil and gas property theretofore acquired, producing and selling oil therefrom, and carried on no other business in 1936.

Petitioner further contends that the income tax paid to the state can not properly be classified as operating expense, because it represents merely the payment of a part of the net profits to the Government, citing and quoting at length from I. T. 3398, construing regulations issued under the Vinson Act (48 Stat. 503), as amended. This ruling in effect held that a state franchise tax measured by income but imposed upon the privilege of doing business as a corporation within the state is includable as an element of the cost of performing