Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 75-6

1975-1 C.B. 178

Sec. 451
Sec. 611

IRS Headnote

Depletion; gross income from property; compression of natural gas prior to sale. Gross income from property does not include that portion of the selling price of natural gas attributable to the taxpayer's process of compressing the gas, to meet purchaser's specifications, prior to its delivery to the purchaser's pipeline.

Full Text

Rev. Rul. 75-6

Advice has been requested whether, under the circumstances described below, the portion of the selling price attributable to the cost of compressing natural gas for the purpose of introducing it into the purchaser's pipeline is includible in the taxpayer's "gross income from the property" under section 613 of the Internal Revenue Code of 1954.

The taxpayer produces crude oil containing gas in solution from its oil and gas wells. The produced crude oil and gas in solution flows to a central tank battery where the solution gas is removed by a mechanical separator. The pressure of the separated gas is increased by compression, and then delivered to the purchaser's pipeline, where it is sold at a metering station located down stream of the discharge side of the compressor.

The gas is compressed so that it will meet the specifications of the purchasing pipeline company. The taxpayer receives a higher price for his gas as a result of performing the compression operation that otherwise would have had to be undertaken by the purchaser.

Section 613(a) of the Code provides, in part, that in the case of oil and gas wells, the allowance for depletion under section 611 shall be the percentage of the gross income from the property specified in section 613(b) for oil and gas wells. Section 1.613-3(a) of the Income Tax Regulations provides that in the case of oil and gas wells gross income from the property means the amount for which the taxpayer sells the oil and gas in the immediate vicinity of the well. This section of the regulations also provides that if the oil or gas is manufactured or converted into a refined product prior to sale, the gross income from the property shall be assumed to be equivalent to the representative market or field price of the oil or gas before such manufacturing or conversion.

The compression of natural gas, such as occurred in the instant case, is a manufacturing process that adds value to the gas by converting it into a product with a higher delivery pressure. Income attributable to manufacturing processes that increase the value of natural gas does not constitute gross income from the property under section 613(a) of the Code. See section 1.613-3(a) of the regulations; Mountain Fuel Supply Company v. United States, 449 F.2d 816 (10th Cir. 1971), cert. denied, 405 U.S. 989 (1972).

Accordingly, the portion of the selling price attributable to the cost of compressing natural gas before delivery to the purchaser's pipeline is not includible in the taxpayer's gross income from the property.