Rev. Rul. 84-88

1984-1 C.B. 141, 1984-25 I.R.B. 13.

                       Internal Revenue Service
                                 Revenue Ruling

                         DEPLETION;  ECONOMIC INTEREST

                            Published: June 18, 1984

Section 611. - -Allowance of Deduction for Depletion, 26 CFR 1.611-1:  Allowance of deduction for depletion.

  Depletion;  economic interest.  A mining company as operator has an economic interest under an agreement that requires the delivery of all extracted coal to the owner, who applies additional mining processes and shares the proceeds received on the sale of the processed coal at specified percentages.  A stated minimum amount payable to the operator did not negate the economic interest under the specific facts of the case.

ISSUE

  Does taxpayer possess an economic interest in coal under section 1.611- 1(b)(1) of the Income Tax Regulations under the circumstances described below?

FACTS

  The owner of coal properties (X) and a mining company (taxpayer) entered into an agreement by which X granted the taxpayer the exclusive right to mine coal from the specified coal seams until all coal has been mined.  The taxpayer is required to deliver all of the coal produced to X who applies only mining processes as defined in section 613(c)(4)(A) of the Internal Revenue Code and sells the processed coal to others.

  The agreement provides that the taxpayer mine the coal in return for a 70- percent share of the net proceeds of the processed coal sold.  The agreement further provides that the taxpayer will receive a minimum amount of $22x on each ton of the first 1000y tons of coal processed and sold.  This minimum amount will be paid to the taxpayer by X on each ton of the first 1000y tons that are processed and sold if 70 percent of the net proceeds is less than such minimum amount.  However, in no event, will X pay the taxpayer more than the net proceeds of any sale.  Furthermore, at the time they entered into the agreement, the coal reserves were 5000y tons.  The agreement also provides that X will be entitled to recoup, out of the taxpayer's 70 percent share of net proceeds in excess of $22x, any amounts that X previously paid to the taxpayer that exceeded 70 percent of the net proceeds.

LAW AND ANALYSIS

  Section 1.611-1(b)(1) of the regulations provides for annual depletion deductions to the owner of an economic interest in mineral deposits.  An economic interest is possessed when the taxpayer has acquired by investment an interest in mineral in place and secures, by any form of legal relationship income derived from the extraction of the mineral to which he must look for a return of his capital.

  For the taxpayer to have an economic interest in minerals in place, it is essential that the consideration received for the minerals, under the terms of an agreement, represents literally a share of the minerals extracted or proceeds from their sales, and that the taxpayer be dependent upon such consideration for a return of his capital.  See Palmer v. Bender, 287 U.S. 551 (1933), XII-1 C.B. 235 (1933).

  In Rev. Rul. 74-469, 1974-2 C.B. 177, a lessee under various mineral leases, with the right to extract and sell certain minerals, granted to Y the right to mine such minerals to exhaustion.  Y had the burden of extracting the minerals from the ground and delivering them to a stockpile.  Lessee had the burden of transporting and processing the minerals and of paying all production royalties. Upon severance from the ground all minerals became the property of lessee and Y individually in specified shares, and an independent agent sold the minerals on the open market for the accounts of lessee and Y.  Rev. Rul. 74-469 holds that both lessee and Y obtained an economic interest in their respective shares of the minerals in place.

  The situation in this ruling differs from that in Rev. Rul. 74-469 in that (1) the taxpayer does not have the right to sell its share of the coal produced because the coal is to be delivered to X who sells the coal after processing, and (2) the taxpayer receives 70 percent of the net proceeds from the sale of the processed coal, but not less than $22x per ton (or the net proceeds, if less than $22x) for a specified basic tonnage.  Nevertheless, the taxpayer acquired from X separate contractual rights to mine coal to exhaustion and to look to the sale of the coal for the return of its investment.  The income to the taxpayer is dependent solely on the eventual sale of the coal. Therefore, the taxpayer has acquired an economic interest in the coal in place under section 1.611-1(b)(1) of the regulations.

HOLDING

  The taxpayer possesses an economic interest in coal in place under section 1.611-1(b)(1) of the regulations.

Rev. Rul. 84-88, 1984-1 C.B. 141, 1984-25 I.R.B. 13.