Rev. Rul. 85-12

1985-1 C.B. 181.

PERCENTAGE DEPLETION; INDEPENDENT PRODUCER; EFFECT OF RETAILER SISTER

CORPORATION SALES ON PRODUCER CORPORATION SALES; RETAILER EXCLUSION PRINCIPLES

Published:  1985

Section 613A.--Limitations on Percentage Depletion in Case of Oil and Gas Wells

(Also Section 4987;  26 CFR 150.4987-1.)

  Percentage depletion;  independent producer;  effect of retailer sister corporation sales on producer corporation sales;  retailer exclusion principles.  Where none of a producer's production is sold through a related retailer and the producer has no direct or indirect ownership interest in the retailer, the producer is not precluded from taking percentage depletion under section 613A(c) or from being an independent producer for purposes of the windfall profit tax under section 4987(b)(2).

ISSUE

  Is a corporation, an oil and gas producer, precluded from taking the percentage depletion deduction as provided by section 613A of the Internal Revenue Code or claiming the reduced rates of the Crude Oil Windfall Profit Tax provided to independent producers by section 4987(b)(2) of the Code because a related sister corporation, through which the producer does not sell its production, is a retailer as defined in section 613A(d)(2) of the Code?

FACTS

  X, a wholly-owned subsidiary of Y corporation, is the owner of various working and royalty interests in oil and gas leases located throughout the United States.  All of X's sales of produced oil and gas are made at or near the wellhead to unrelated parties.  It acts neither as a refiner nor a retailer, and standing on its own, X would be entitled to claim percentage depletion under section 613A(c) of the Code and would be classified as an independent producer for windfall profit tax purposes under section 4992 of the Code.

  Z is also a wholly owned subsidiary of Y, and a sister company to X.  Z has engaged in marketing of petroleum and petroleum products for the past several years.  It purchases petroleum or derivative products from unrelated third parties, and resells such products at a profit through retail outlets.  Sales by Z to end users exceed $5,000,000 annually or $1,250,000 per quarter.

  X and Z, along with other subsidiaries of Y, join together in the filing of a consolidated U.S. Corporate Income Tax Return.

LAW AND ANALYSIS

  Section 613A(a) of the Code provides that, except as otherwise provided in section 613A, the allowance for depletion under section 611 with respect to any oil or gas well shall be computed without regard to section 613, which provides the allowance for percentage depletion.

  Section 613A(c) of the Code provides that, except as provided in section 613A(d), the allowance for depletion under section 611 shall be computed in accordance with section 613 with respect to so much of the taxpayer's average daily production of domestic crude oil as does not exceed the taxpayer's depletable oil quantity;  and so much of the taxpayer's average daily production of domestic crude oil as does not exceed the taxpayer's depletable oil quantity;  and so much of the taxpayer's average daily production of domestic natural gas as does not exceed the taxpayer's depletable natural gas quantity;  and the applicable percentage (determined in accordance with the table contained in paragraph (5)) shall be deemed to be specified in subsection (b) of section 613 for purposes of subsection (a) of that section.

  Section 613A(d)(2) of the Code provides that section 613A(c) shall not apply in the case of any taxpayer who directly, or through a related person, sells oil or natural gas (excluding bulk sales or such items to commercial or industrial users), or any product derived from oil and natural gas through any retail outlet operated by the taxpayer or a related person or to any person (i) obligated under an agreement or contract with the taxpayer or a related person to use a trademark, trade mark, or service mark or name owned by such taxpayer or related persons, in marketing or distributing oil or natural gas or any product derived from oil or natural gas, or (ii) given authority, pursuant to an agreement or contract with the taxpayer or a related person, to occupy any retail outlet owned, leased, or in any way controlled by the taxpayer or a related person.

  Section 613A(d)(2) of the Code further provides that such limitation upon the allowance for percentage depletion does not apply in any case where the combined gross receipts from the sale of oil, natural gas, or any product derived from oil and gas for the tax year of all retail outlets do not exceed $5,000,000.

  Section 613A(d)(3) of the Code provides that a person is a related person with respect to the taxpayer if a significant ownership interest in either the taxpayer or such person is held by the other, or if a third person has a significant ownership interest in both the taxpayer and such person.  For purposes of the preceding sentence, the term "significant ownership interest" means, with respect to any corporation, 5 percent or more in value of the outstanding stock of such corporation.

  Section 4992(b) of the Code provides that for purposes of the windfall profit tax, with respect to any quarter, a person to whom section 613A(c) does not apply by reason of section 613A(d)(2) relating to certain retailers is not an independent producer.  For the purposes of defining an independent producer, section 4992(b)(2) provides that section 613A(d) is to be applied by substituting "quarter" for "taxable year" each place it appears in paragraph 613A(d)(2) and by substituting $1,250,000 for $5,000,000 in section 613A(d)(2).  Thus, a "retailer" is also prohibited from utilizing the reduced rates on independent producer oil provided in section 4987(b)(2).

  Where none of a producer's production is sold through a related retailer, the producer does not lose the benefit of the section 613A(c) exemption if an owner of 5 percent or more of its stock is a retailer because the producer does not benefit from the retailer's retail sales of oil and gas.  The producer, X, has no direct or indirect ownership interest in the retailer, Z, and, thus, does not benefit from the retail sales.  Although the two corporations X and Z are related persons for purposes of section 613A(d) by virtue of the provisions of section 613A(d)(3), none of X's production is, in form of substance, sold through Z.  Thus, X is not precluded from taking percentage depletion under section 613A(c) or from being listed as an independent producer for purposes of the windfall profit tax under section 4987(b)(2).

HOLDING

  Corporation X is not precluded from taking the percentage depletion deduction as provided in section 613A of the Code, or claiming the reduced rates of windfall profit tax provided by section 4987(b)(2) by virtue of the fact that a related sister company, Z, through which X does not sell its production, is a retailer as defined in sections 613A(d)(2) and 4992(b).

Rev. Rul. 85-12, 1985-1 C.B. 181.