Rev. Rul. 80-72
1980-1 C.B. 109, 1980-11 I.R.B. 9.
Internal Revenue Service
Revenue Ruling
FOREIGN GOLD MINE; AMOUNT AT RISK
Published: March 17, 1980
Section 465.--Deductions Limited to Amount at Risk
Foreign gold mine; amount at risk. A taxpayer invested a specified amount in a tax shelter arrangement whereby the taxpayer leased a foreign mining company's interest in a gold reserve. The taxpayer authorized the promoter of the arrangement to sell an option on the gold to be extracted and stipulated that the proceeds from the sale of the option and the original investment were to be used for development of the gold reserve. The option can only be exercised after the gold has been extracted, and the holder of the option cannot compel the extraction. The taxpayer is not at risk, within the meaning of section 465 of the Code, with respect to the proceeds from the sale of the option.
ISSUE
Do the 'at risk' provisions of section 465 of the Internal Revenue Code apply under the circumstances described below?
FACTS
In 1979, M, a consortium of private foreign corporations, marketed a tax shelter arrangement purporting to give investors a tax write-off equal to four times the cash invested. A, an individual, invested 100x dollars in the arrangement.
In connection with this investment, A executed the following documents:
1. A 'mineral claim lease' whereby A leases from P, a foreign mining company, the mineral rights to a gold reserve located in X, a foreign country. Under the lease, A is entitled to explore, develop and extract all recovered gold on the premises until 1986, the date of expiration of the lease. A must pay P a certain royalty per gram for all the recovered gold after first deducting all the tax due to X, extraction costs and the development costs. A also agreed to expend 400x dollars for the development to ready the claim for extraction no later than December 31, 1979. However, A is not obligated to extract the gold. Whether and when the gold is actually extracted is within the control of A.
2. An authorization agreement under which A authorizes M to sell for 300x dollars a gold option, described below, on the total minerals to be extracted under the terms of the mineral claim lease. The authorization further specifies that the proceeds from the sale of the gold option shall be used with the 100x dollars remitted by A to pay for development of the claim by a contractor that M retains on A's behalf.
3. A gold option by which for a 300x dollar premium, A grants to C, a party obtained by M, the option to purchase all the gold contained in the mineral claim lease subject to the tax due to X, lessor royalty, development costs, and extraction cost. After payment of the above costs, the exercise price for the remaining gold shall be approximately one-third the current fair market value of gold. C as option holder agrees that the option can only be exercised after the gold has been extracted. Further, C cannot compel the extraction of gold. If necessary arrangements are not made for extracting the gold prior to the expiration date of the option in 1986, A acknowledges and agrees that the option holder has the first right of refusal for entering into a new lease for the mineral claim with P. In the gold option, M represents that gold in commercially marketable quantities has been shown to exist in the mineral claim.
After receipt of the above, M sent A copies of the executed documents in addition to invoices and cancelled checks for development of the mining claim in the amount of 400x dollars. These were dated on or before December 31, 1979. On A's 1979 tax return, A claimed a 400x dollars deduction for development expenditures under section 616(a) of the Code.
LAW AND ANALYSIS
Section 616(a) of the Code provides the except where the taxpayer elects otherwise as provided in section 616(b), there shall be allowed as a deduction in computing taxable income all expenditures paid or incurred during the taxable year for the development of a mine or other natural deposit (other than an oil or gas well) if paid or incurred after the existence of ores or minerals in commercially marketable quantities has been disclosed.
Section 465 of the Code provides that in the case of an individual engaged in an activity to which this section applies, any loss from such activity for the taxable year shall be allowed only to the extent of the aggregate amount with respect to which the taxpayer is at risk (within the meaning of subsection (b)) for such activity at the close of the taxable year.
For taxable year beginning after December 31, 1978, section 465(c)(3)(A) of the Code provides that section 465 applies to each activity engaged in by the taxpayer in carrying on a trade or business or for the production of income.
Section 465(b)(1) of the Code provides that a taxpayer shall be considered at risk for an activity with respect to amounts, including the amount of money and the adjusted basis of other property, contributed by the taxpayer to the activity, and amounts borrowed with respect to such activity (as determined under paragraph (2)).
Section 465(b)(2) of the Code provides that a taxpayer shall be considered at risk with respect to amounts borrowed for use in an activity to the extent that the taxpayer is personally liable for the repayment of such amounts or has pledged property, other than property used in such activity, as security for such borrowed amount.
Section 465(b)(4) of the Code provides that notwithstanding any other provision of this section, a taxpayer shall not be considered at risk with respect to amounts protected against loss through nonrecourse financing, guarantees, stop loss agreements, or other similar arrangements.
See the Senate Committee on Finance Report on the Tax Reform Act of 1976, S. Rep. No. 94-938, 94th Cong., 2d Sess. 1 (1976), 1976-3 C.B. (Vol. 3) 57, at 87.
The legislative history indicates that Congress intended the at risk provisions to cover arrangements the effect of which is to insulate taxpayers from 'economic loss.'
In this case, A has obtained 300x dollars by selling an option that can be exercised only if gold is found and extracted by or on behalf of A. If no gold is found, or if A fails to extract any gold found, A will have no obligation to the option holder, C. Moreover, as part of the same arrangement, A will expend the 300x dollars (plus the 100x dollars remitted by A) to pay for development of the claim. Thus, A's at risk position in relation to the 300x dollars is substantially the same as if the 300x dollars had been borrowed from C on a nonrecourse basis repayable only from A's interest in the activity. Under these facts the selling of the option is an 'other similar arrangement' to nonrecourse financing as provided in section 465(b)(4), whereby A is effectively protected from any true economic risk.
HOLDING
A is not at risk within the meaning of section 465 of the Code with respect to the 300x dollars premium received on the sale of the option. Further the 100x deduction attributable to A's actual cash investment is deductible on A's 1979 tax return only to the extent that A can prove that it was expended during the taxable year for the development of a mine and that the existence of ores in commercially marketable quantities had previously been disclosed in that mine.
Rev. Rul. 80-72, 1980-1 C.B. 109, 1980-11 I.R.B. 9.