This case presents the question whether respondent, Wilshire Oil Company, Inc., in computing its net income for the years 1929 and 1930 for the purpose of applying the 50 per cent limitation on depletion allowance under § 114(b)(3) of the Revenue Act of 1928, 45 Stat. 791, 26 U.S.C.A. Int.Rev.Acts, page 384, may refuse to take as deductions certain development expenditures, where it has deducted those development expenditures in computing its taxable net income for those years. The Board of Tax Appeals held for the respondent (35 B.T.A. 450) and that decision was affirmed by the Circuit Court of Appeals, one judge dissenting (9 Cir., 95 F.2d 971). Because of the importance of the problem of the scope of the Commissioner's rule-making power and because of an asserted conflict of the decision below with the decision of the Circuit Court of Appeals for the Fifth Circuit in Commissioner of Internal Revenue v. F.H.E. Oil Co., 102 F.2d 596, we granted certiorari, 306 U.S. 628, 59 S.Ct. 773, 83 L.Ed. 1031.
Respondent is engaged in the business of producing oil and gas from its various properties. In computing taxable net income in its returns for 1929 and 1930 respondent, pursuant to the regulations, deducted development expenditures in the respective amounts of $606,051.66 and $279,927.04. But it refused to make those deductions in determining its 'net income * * * from the property' for the same years, when computing allowable depletion under § 114(b) (3) of the Revenue Act of 1928.
'In the case of oil and gas wells the allowance for depletion shall be 27 1/2 per centum of the gross income from the property during the taxable year. Such allowance shall not exceed 50 per centum of the net income of the taxpayer (computed without allowance for depletion) from the property, except that in no case shall the depletion allowance be less than it would be if computed without reference to this paragraph.'
By virtue of § 23 of the Revenue Act of 1928, 26 U.S.C.A. Int.Rev.Acts, page 356, companies like respondent were allowed as deductions in computing net income a 'reasonable allowance for depletion * * * according to the peculiar conditions in each case; such reasonable allowance in all cases to be made under rules and regulations to be prescribed by the Commissioner, with the approval of the Secretary.' Pursuant to that rule-making power the phrase 'net income of the taxpayer (computed without allowance for depletion)' as used in § 114(b)(3) was defined by Treasury Regulations 74, Art. 221(i) promulgated under the 1928 Act as meaning 'gross income from the sale of oil and gas' less certain deductions including 'development expenses (if the taxpayer has elected to deduct development expenses) * * * but excluding any allowance for depletion'. For 1925 respondent, having the option to treat these expenses as deductions for development expenses or as charges to the capital account returnable through depletion, chose the former.
On these facts it would seem that Treasury Regulations 74, Art. 221(i) would require respondent to deduct development expenses in computing 'net income' as used in § 114(b)(3), since respondent fell clearly within the class described therein.