Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 73-33

1973-1 C.B. 307

Sec. 631
Sec. 1231

IRS Headnote

Royalties received by a company from the lease of coal lands to a joint venture that includes as a member the company's wholly-owned subsidiary and that sells the coal to the company are subject to treatment under section 631 of the Code.

Full Text

Rev. Rul. 73-33

Advice has been requested whether the royalties received by a coal lessor under the circumstances described below are subject to the treatment provided under section 631(c) of the Internal Revenue Code of 1954.

A thermal-electric power company, lessor of certain coal lands, leased its coal lands held longer than six months to a joint venture, determined on examination to be classified as a partnership for purposes of the Internal Revenue Code of 1954. One of the members of the joint venture was a wholly owned subsidiary of the power company. The other member of the joint venture was an unrelated mining company. The joint venture pays a royalty to the power company when the coal is mined. The amounts received as royalties were fair and reasonable, when judged by the standard of transactions entered into by parties dealing at arm's length. The joint venture has an economic interest in the coal lands it leased from the power company.

Simultaneously with the execution of the coal lease, the joint venture entered into a coal supply agreement with the power company. Under the coal supply agreement, the power company buys coal from the joint venture to meet all of the requirements of one of its power plants. The coal lease and the coal supply agreement are co-terminous.

Section 631(c) of the Code and the regulations thereunder provide that the income received from the disposal of coal mined in the United States, if the coal is held for more than six months before disposal and the owner retains an economic interest in the coal, shall be considered as income from the sale of such coal and the coal shall be considered to be property to which the provisions of section 1231 of the Code are applicable. However, the provisions of section 631(c) of the Code do not apply to income realized by any owner as co-adventurer, partner, or principal in the mining of the coal land. The word "owner" means any person who owns an economic interest in the coal, including a sub-lessor.

Section 1231 of the Code provides in part that if, during the taxable year, the recognized gains on sales or exchanges of property used in the trade or business, plus the recognized gains from compulsory or involuntary conversion of property used in the trade or business and capital assets held for more than six months into other property or money, exceeded the recognized losses from such sales, exchanges and conversions, such gains shall be considered as gains and losses from sales or exchanges of capital assets held for more than six months. If such gains do not exceed such losses, such gains and losses shall not be considered as gains and losses from sales or exchanges of capital assets.

The royalty interest retained by the power company under the coal lease in this case is an economic interest of an "owner" within the meaning of section 631(c) of the Code.

The terms co-adventurer, partner, or principal imply a sharing of the risk and control of a mining venture so that income to such taxpayer is derived from direct operation of a mine rather than passive income as a lessor or sub-lessor retaining an economic interest. The power company has no direct control of the mining operation and does not share in the risk of mining. The income of the power company is that of a lessor and, as such, is passive income arising from the retention of its economic interest upon leasing its coal lands.

Accordingly, the royalty income of the thermal-electric power company received from the coal lease in this case is considered as income from the sale of such coal, subject to the treatment provided under section 631 of the Code, and section 1231 of the Code.