Internal Revenue Service
Revenue Ruling
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smRev. Rul. 77-84
1977-1 C.B. 173
Section 611
Section 631
IRS Headnote
Depletion; coal royalty received for services. A royalty interest in a coal lease received by an individual from a coal company for services in obtaining that lease, or other leases, for the company is not subject to capital gains treatment under section 631(c) of the Code, but is ordinary income subject to percentage depletion. Amounts received by the individual for obtaining coal leases determined by a rate per ton of coal purchased and processed by the coal company are not subject to capital gains treatment, but are ordinary income not subject to depletion.
Full Text
Rev. Rul. 77-84
Advice has been requested whether, under the three factual situations described below, the royalty payments received by an individual are subject to capital gains treatment under the provisions of section 631(c) of the Internal Revenue Code of 1954, or whether these payments are ordinary income subject to an allowance for depletion under the provisions of section 611(a).
Situation (1). An agreement between A, an individual, and M, a coal mining company, provided that for services previously performed by A in obtaining a coal lease for M, A was to receive a royalty interest on the lease acquired by M, as a result of negotiations carried out and accomplished by A on behalf of M.
Situation (2). An agreement between A, an individual, and M, a coal mining company, provided that for services previously performed by A in obtaining coal leases for M, A was to receive a royalty interest in a lease other than those negotiated by A on behalf of M.
Situation (3). An agreement between A, an individual, and M, a coal mining company, provided that for services previously performed by A in obtaining coal leases for M, A was to receive a specified amount per ton for each ton of coal purchased by M from a third party and processed through M's coal preparation plant.
Section 611(a) of the Code provides, in part, that in the case of mines, oil and gas wells, other natural deposits, and timber, there shall be allowed as a deduction in computing taxable income a reasonable allowance for depletion.
Section 1.611-1(b)(1) of the Income Tax Regulations provides, in part, that annual depletion deductions are allowable only to the owner of an economic interest in mineral deposits. An economic interest is possessed in every case in which the taxpayer has acquired by investment any interest in mineral in place and secures, by any form of legal relationship, income derived from the extraction of the mineral, to which the taxpayer must look for a return of capital. A person who has no capital investment in a mineral deposit does not possess an economic interest merely because through a contractual relationship that person possesses an economic or pecuniary advantage derived from production.
Section 631(c) of the Code provides that in the case of the disposal of coal, held for more than 6 months before such disposal under any form of contract under which the owner retains an economic interest, certain amounts shall be considered as though they were a gain or loss on the sale of such coal, unless the income is realized by the owner as a co-adventurer, partner, or principal in the mining of such coal.
Section 1.631-3(a)(1) of the regulations provides, in part, that:
* * * The provisions of section 631(c) apply to an owner who disposes of coal * * *, held for more than 6 months before such disposal under any form or type of contract whereby he retains an economic interest in such coal * * *.
However, section 1.631-3(b)(4)(i) of the regulations states, in part, that:
* * * A person who merely acquires an economic interest and has not disposed of coal * * * under a contract retaining an economic interest does not qualify under section 631(c). * * *
In Situation (1), A acquired an interest in the coal mined by M from a leased acquired by M as a result of services previously performed by A. Future payments from M to A are dependent solely upon the extraction and sale of coal produced from M's lease. A has acquired a royalty interest in mineral in place and will secure income derived from the extraction of the mineral. A therefore has an economic interest in the mineral deposit. However, A merely acquired the economic interest and did not dispose of coal under a contract wherein A retained an economic interest.
Accordingly, the payments received by A will not be subject to capital gain treatment under section 631(c) of the Code but will be ordinary income subject to depletion.
In Situation (2), A acquired an interest in the coal mined by M from leases owned by M that were not ac-acquired through the services of A. Future payments from M to A are dependent solely upon the extraction and sale of the coal produced from M's lease. A has acquired a royalty interest and will secure income derived from the extraction of the mineral. A therefore has an economic interest in the mineral deposit. However, A merely acquired the economic interest and did not dispose of coal under a contract wherein A retained an economic interest.
Accordingly, the payments received by A will not be subject to capital gain treatment under section 631(c) of the Code, but will be ordinary income subject to depletion.
In Situation (3), A was to receive future payments measured by the amount of coal purchased by M from a third party and processed through M's plant rather than payments measured by the amount of coal extracted. A has not acquired an interest in mineral in place and will not secure income derived from extraction of the mineral. A therefore has not acquired an economic interest and did not dispose of coal under a contract wherein A retained an economic interest.
Accordingly, the payments received by A will not be subject to capital gain treatment under section 631(c) of the Code, but will be ordinary income not subject to depletion.