Rev. Rul. 84-36
1984-1 C.B. 143, 1984-10 I.R.B. 8.
Internal Revenue Service
Revenue Ruling
PERCENTAGE DEPLETION; PROPORTIONATE PROFITS METHOD
Published: March 5, 1984
26 CFR 1.613-4: Gross income from the property in the case of minerals other than oil and gas
Percentage depletion; proportionate profits method. The cost or value of carbon monoxide gas produced during a nonmining process is not considered a mining cost and a reduction of nonmining costs when that gas is used as fuel in a mining process for purposes of the proportionate profits computation.
ISSUE
Should the cost or value of carbon monoxide gas produced during a nonmining process be considered a mining cost and a reduction of nonmining costs when that gas is used as fuel in a mining process by an integrated miner- manufacturer who computes gross income from mining under the proportionate profits method as described in section 1.613-4(d)(1) of the Income Tax Regulations.
FACTS
The taxpayer owns and operates a phosphate ore mine and a processing plant to produce elemental phosphorus. The phosphate ore is extracted, hauled to the plant, and stockpiled. The ore is then nodulized in a rotary kiln. The nodulization of phosphate rock is a mining process under section 1.613- 4(f)(2)(i)(e)(4) of the regulations. The nodules are blended with silica and coke and fed into an electric furnace where the nodules are reduced to elemental phosphorus. Carbon monoxide gas is generated as a by-product in the electric furnace during the reduction process. The gas is used as a fuel to heat the kiln in the nodulizing process. The taxpayer incurs no additional costs in order to produce and use the carbon monoxide gas. The costs of the electric furnace process will be the same regardless of whether the taxpayer uses the carbon monoxide, vents it into the air, or sells it to a third party.
The taxpayer uses the proportionate profits method to compute gross income from mining for purposes of determining percentage depletion because a representative market or field price for the phosphate nodules cannot be ascertained.
LAW AND ANALYSIS
Section 611(a) of the Code provides that in the case of mines and other natural deposits, there shall be allowed as a deduction in computing taxable income a reasonable allowance for depletion. The amount of this depletion deduction is set by section 613(a), which provides that in the case of mines and other natural deposits, the allowance for depletion shall be the percentage specified in section 613(b) of the gross income from the property. Section 613(c)(1) defines the term "gross income from the property," in the case of property other than an oil and gas well or geothermal deposit, as the "gross income from mining."
Section 1.613-4(d)(l)(i) of the Income Tax Regulations provides for the use of the proportionate profits method for computing gross income from mining in cases in which a representative market or field price cannot be determined. It also provides that a method of computing gross income from mining under the provisions of that paragraph shall not be deemed to be a method of accounting for purposes of section 1.446-1(e).
Section 1.613-4(d)(2) of the regulations provides that in determining gross income from mining by use of methods based on the taxpayer's costs, only costs actually paid or incurred shall be taken into consideration.
Section 1.613-4(d)(4) of the regulations states that the objective of the "proportionate profits method" is to ascertain gross income from mining by applying the principle that each dollar of the total costs paid or incurred to produce, sell and transport the first marketable product or group of products means those products produced by application of nonmining processes in the form or condition in which such products are first marketed. The proportionate profits methods involves multiplying the gross sales (actual or constructive) of the first marketable product or group of products by a fraction whose numerator is the sum of mining costs and whose denominator is the total of all mining and nonmining costs.
Section 1.613-4(d)(4)(v)(a) of the regulations specifies that the term "gross sales (actual or constructive)" means the total of the taxpayer's actual competitive sales to others of the first marketable product or group of products, plus the taxpayer's constructive sales of the first marketable product or group of products used or retained for use in its own subsequent operations.
The carbon monoxide is a by-product when the elemental phosphorus is produced from the phosphate ore nodules in the electric furnace reduction process. The use of the carbon monoxide gas as a fuel results in a cost savings to the taxpayer in operating the nodulizing kiln. However, this cost savings has no effect upon the allocation of the taxpayer's actually incurred mining and nonmining costs. Since the taxpayer incurs no additional costs in order to produce and use this carbon monoxide gas, neither the value of the gas nor any portion of the cost of the electric furnace process can be considered mining costs or as a reduction in nonmining costs for purposes of the proportionate profits method, regardless of the method of cost accounting used by the taxpayer. Section 1.613-4(d)(2) of the regulations provides that only costs paid or incurred will be taken into consideration.
HOLDING
The cost or value of carbon monoxide gas produced during a nonmining process, where no additional cost is incurred in producing the gas, is not considered a mining cost and is not a reduction of nonmining costs when that gas is used as fuel in a mining
process by an integrated miner-manufacturer who computes gross income from mining under the proportionate profits method as described in section 1.613-4(d)(1) of the regulations.
Rev. Rul. 84-36, 1984-1 C.B. 143, 1984-10 I.R.B. 8.