Rev. Rul. 83-46

1983-1 C.B. 16, 1983-12 I.R.B. 5.

                       Internal Revenue Service
                                 Revenue Ruling

        ROYALTY INTERESTS;  OIL AND GAS INTERESTS ACQUIRED FOR SERVICES

                           Published: March 21, 1983

SECTION 83. - -PROPERTY TRANSFERRED IN CONNECTION WITH PERFORMANCE OF SERVICES, 26 CFR 1.83-1: Property transferred in connection with the performance of services

  Royalty interests;  oil and gas interests acquired for services.  A corporate promoter, an attorney, and an employee of a closely held corporation, receive overriding royalty interests for services provided in connection with the acquisition/development of oil and gas leases.  Each has received a property interest, the fair market value of which is includible in gross income under section 83 of the Code.

ISSUE

  Whether section 83 of the Internal Revenue Code requires taxpayers to include in gross income overriding royalty interests received under the situations described below.

FACTS

  Situation (1): X corporation syndicates partnerships that acquire interests in oil and gas properties and take advantage of the intangible drilling and development costs deduction.  X entered into an agreement with one such partnership, PRS, that provides that X will receive an overriding royalty interest (as described in Rev. Rul. 67-118, 1967-1 C.B. 163) in consideration for its services in locating available oil and gas properties for PRS.  Under the agreement, X received, in 1983, several such overriding royalty interests in oil and gas to be produced from leases acquired by PRS.

  Situation (2): A, an attorney, is retained by Y corporation, in connection with Y's acquisition of oil and gas properties.  In 1983, A conducted title examinations for oil and gas properties and drafted a number of lease agreements under which Y acquired the minerals in place.  A and Y agreed that for each such lease Y acquired, A would receive, in 1983, an overriding royalty interest (as described in Rev. Rul. 67-118) in the oil and gas to be produced under the lease.

  Situation (3): B, an employee of Z, a closely held corporation, is responsible for the administrative and policy matters of Z.  B's duties include arranging financing for the acquisition and development of oil and gas properties located by Z's technical staff and overseeing the operations of Z in developing the properties.  For these services, in 1983, B received from Z a salary plus an overriding royalty interest (as described in Rev. Rul. 67-118) in the oil and gas to be produced from each lease acquired by Z.

LAW AND ANALYSIS

  Section 83(a) of the Code and the regulations thereunder provide that, if, in connection with the performance of services, property is transferred to any person other than the person for whom such services are performed, the excess of (1) the fair market value of the property at the first time the rights of the person having the beneficial interest in the property are transferable or are not subject to a substantial risk of forfeiture, whichever occurs earlier, over (2) the amount (if any) paid for the property, is included in the gross income of the person who performed the services.  The taxable year of inclusion is generally the first taxable year in which the rights of the person receiving the property are substantially vested, i.e., transferable or not subject to a substantial risk of forfeiture.  See section 1.83-3(b) of the regulations.

  Rev. Rul. 67-118 provides that an overriding royalty interest may be defined as an economic interest of oil and gas in place, created from the working interest that entitles its owner to a specified fraction of gross production, free of operating and development costs.  The term of an overriding royalty interest is coextensive with the term of the working interest from which it was created.  Thus, the transfer of an overriding royalty is an assignment of a property interest and is not an anticipatory assignment of income.

  In the above situations, X, A, and B have each received property interests in the form of overriding royalties for the services each performed in connection with the oil and gas leases acquired and/or developed by PRS, Y, and Z.

HOLDINGS

  In 1983, X, A, and B must include in gross income the fair market value of each overriding royalty interest received pursuant to section 83 of the Code.

Rev. Rul. 83-46, 1983-1 C.B. 16, 1983-12 I.R.B. 5.