Rev. Rul. 80-48

1980-1 C.B. 99, 1980-8 I.R.B. 11.

                       Internal Revenue Service
                                 Revenue Ruling

       MINERAL PRODUCTION PAYMENTS; GAS; "TAKE OR PAY" PURCHASE CONTRACT

                          Published: February 25, 1980

Section 451.--General Rule for Taxable Year of Inclusion, 26 CFR 1.451-1: General rule for taxable year of inclusion.

(Also Section 636; 1.636-1.)

  Mineral production payments; gas; "take or pay" purchase contract. Payments received for gas that is to be taken in the future under a "take or pay" gas purchase contract are not mineral production payments under section 636(a) of the Code and are includible in gross income under the provisions of section 451.

ISSUE

  Are the payments received by the taxpayer for gas, to be taken in the future under a 'take or pay' gas purchase contract, mineral production payments for federal income tax purposes under section 636(a) of the Internal Revenue Code?

FACTS

  The taxpayer sells gas to corporation Y under the provisions of a 'take or pay' gas purchase contract.

  Under the provisions of the contract, corporation Y purchases a specified amount of gas from the taxpayer each month. However, corporation Y is not obligated to take such monthly production.

  The contract provides that the taxpayer will receive monthly payments from Y based upon a predetermined production schedule, whether or not Y takes the monthly production.  To the extent the taxpayer receives payments from Y in excess of the production taken by Y, a deficiency in the 'take' exists.  Y has the right during any of the subsequent years of the 20 year contract life to make up any deficiency by taking production in excess of the monthly scheduled production.

LAW AND ANALYSIS

  Section 451 of the Code provides that the amount of any item of gross income shall be included in the gross income for the taxable year in which received by the taxpayer, unless, under the method of accounting used in computing taxable income, such amount is to be properly accounted for as of a different period.

  Section 1.451-5(g) of the Income Tax Regulations provides that a transaction that is treated as creating a mortgage loan pursuant to section 636 of the Code and the regulations thereunder rather than as a sale shall not be considered a 'sale or other disposition' within the meaning of section 1.451-5(a)(1).

  Consequently, any payment received pursuant to such a transaction, that would otherwise qualify as an 'advance payment,' well not be treated as an 'advance payment.'

  Section 1.636-3(a)(1) of the regulations states that the term 'production payment' for purposes of section 636 of the Code means a right to a specified share of the production from mineral in place, if, as, and when produced, or the proceeds from such production. Such right must be an economic interest in such mineral in place.

  An economic interest is defined in section 1.611-1(b) of the regulations as being 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 its capital.  An agreement between the owner of an economic interest and another entitling the latter to purchase the product upon production does not convey a depletable economic interest in mineral in place.

  The taxpayer, in this case, entered into an agreement with Y under the terms of which Y must purchase each month, for the life of the contract, a specified amount of gas.  However, Y need not take the gas.  Under the provisions of section 1.611-1(b) of the regulations such an agreement does not convey a depletable economic interest in mineral in place.

HOLDING

  The payments received for gas to be taken in the future under a 'take or pay' gas purchase contract are not mineral production payments for federal income tax purposes under the provisions of section 636(a) of the Code. Consequently, the payments received are includible in gross income under the provisions of section 451.

Rev. Rul. 80-48, 1980-1 C.B. 99, 1980-8 I.R.B. 11.