Internal Revenue Service
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 Rev. Rul. 55-13

1955-1 C.B. 285

Section 6011 -- Return Filing Requirement

Caution: Superseded by Rev. Rul. 60-257

IRS Headnote

In computing percentage depletion the gross selling price, where a prepayment discount is involved, may be used only in those cases where the discount is a cash discount, not a trade discount, and represents a fair interest rate.

Full Text

Rev. Rul. 55-13

The Internal Revenue Service has been requested to consider whether the gross sales price or the net sales price should be used in determining gross income for percentage depletion purposes. The question involves the same type of situation as was presented in the case of Montreal Mining Company v. Commissioner, 2 T. C. 688, acquiescence, C. B. 1944, 20 (appealed on other grounds to the United States Court of Appeals for the Sixth Circuit).

In that case, the taxpayer was engaged in mining and selling iron ore. Because of the taxpayer's location, its shipments to customers were restricted to the annual navigation season of the Great Lakes, which extends from April through about November 15. The taxpayer contracted with the customer to deliver specific tonnages of ore based on the particular customer's needs for an entire year. Such contracts usually provided for payment in 12 equal installments. The customer, however, had the privilege of discounting any or all installments at a rate approximating the prevailing interest rate upon bank loans.

Subject to certain limitations not here pertinent, the allowance for depletion under section 23(m) of the Internal Revenue Code of 1939, in the case of a taxpayer in the mining industry, is based on a certain percentage "of the gross income from the property during the taxable year." In Montreal Mining Co. v. Commissioner, supra, the court ruled, in effect, that for purposes there pertinent the term "gross income from the property" was not synonymous with the concept of gross income as defined elsewhere in the Code. In fact, the court there stated that under the circumstances presented the term means the amount for which the petitioner sold its ore, an amount which it termed the "selling amount."

After reviewing the particular circumstances surrounding the adoption by the iron ore mining companies of the practice to extend cash discounts to customers, the court in the above-mentioned case distinguished between cash and trade discounts by stating, "It is clear that these discounts are cash discounts made to expedite payments for ore purchased by customers, not trade discounts arising out of market conditions and resulting in a flat rate of prices irrespective of the time of payment. * * * Moreover, there can be no question that they approximate a fair interest rate."

The court compared this principle with the practice of determining cost of inventories by a purchaser of merchandise, as provided by Article 22(c)-3 of Regulations 94 (now sec. 39.22(c)-3 of Regulations 118), wherein it is provided that cost means, in the case of merchandise purchased since the beginning of the taxable year, the invoice price less trade or other discounts, except strictly cash discounts approximating a fair interest rate, which may be deducted or not at the option of the taxpayer, provided a consistent course is followed. The court held that under the authority of these regulations it would appear that petitioner's customers, assuming they used inventories at cost, could treat the discounts in question either as income or a charge against cost, provided a consistent course is followed. On the basis of the foregoing the court reasoned that the petitioner, in keeping with its long and consistent accounting practice and that of the industry, is entitled to treat such discounts as business expenses of the nature of so-called "financial items which are properly deductible as ordinary and necessary expense."

In view of the above, it is the position of the Internal Revenue Service that in computing gross income from the property for purposes of section 23(m) of the Internal Revenue Code, where a prepayment discount is involved the gross selling price may be used only in those cases where the discount is a cash discount, not a trade discount, and represents a fair interest rate.