Rev. Rul. 85-16

1985-1 C.B. 180, 1985-8 I.R.B. 7.

PERCENTAGE DEPLETION; GROSS INCOME FROM THE PROPERTY IN THE CASE OF

MINERALS OTHER THAN OIL AND GAS

Published: February 25, 1985

Section 613.-Percentage Depletion, 26 CFR 1.613-4: Gross income from the property in the case of minerals other than oil and gas.

  Percentage depletion; gross income from the property in the case of minerals other than oil and gas. 'Mining tax' payments made by the taxpayer to the

Province of Ontario, Canada pursuant to the Ontario Mining Tax Act are not royalties and, therefore, such amounts are not excludible from the taxpayer's gross income from mining in computing the percentage depletion under section 613 of the Code.

ISSUE

  Whether 'mining tax' payments made to the Province of Ontario, Canada pursuant to the Ontario Mining Tax Act are royalties, which must be excluded from gross income from mining in computing the percentage depletion deduction under the provisions of section 613 of the Internal Revenue Code.

FACTS

  The taxpayer, a domestic corporation, is engaged primarily in the business of exploring, developing, and producing minerals in the Province of Ontario, Canada. In 1979, the taxpayer acquired title in fee simple to the property containing the mineral. This property, which included the surface and mineral rights, was originally acquired by previous owners by patent from the Province of Ontario in 1907. The Province did not reserve any interest in the property.

  The taxpayer filed Mining Tax Returns in 1980 with the Ontario Department of Mines, reporting and paying the 'mine profits tax' as prescribed by the Ontario Mining Tax Act of 1960, which on the remittance form was described as a royalty.

LAW AND ANALYSIS

  Section 3(1) of the Mining Tax Act of 1960, Chapter 242 of Revised Statutes of Ontario and subsequent amendments of the Mining Tax Act and the regulations thereunder provide that every mine is liable for, and the owner, manager, holder, lessee, tenant, occupier, or operator of the mine shall pay, a tax on the profit (determined in accordance with the Act) of the mine.

  Section 613(a) of the Code and section 1.613-1 of the Income Tax Regulations provide, in the case of mines, that the allowance for depletion under section 611 shall be the percentage, specified in section 613(b), of the gross income from the property, excluding from such gross income an amount equal to any rents or royalties paid or incurred by the taxpayer in respect of the property.

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

  Section 901(b) of the Code provides that the amounts of taxes allowed as a credit under subsection (a) in the case of a domestic corporation shall be the amount of any income, war profits, and excess profits taxes paid to any foreign country.

  Section 903 of the Code provides that the term income, war profits, and excess profits taxes shall include a tax paid in lieu of a tax on income, war profits, or excess profits otherwise generally imposed by any foreign country. The Ontario Mining Tax Act is neither an income tax within the meaning of section 901(b) of the Code nor a tax in lieu of an income tax within the meaning of section 903. See also section 1.901-2 and 1.903-1. Of course, the determination that an amount is not a creditable tax is not determinative of the classification of the payment for purposes of section 613. See, e.g., section 1.901-2A(b)(1). In Inland Steel Co. v. United States, 677 F.2d 72 (Ct. Cl. 1982), the court held that the payments exacted under the Ontario Mining Tax (OMT) do not result from any concept of net gain that would be recognized as the base for an income tax in the United States, but rather, seem to be taxes on the privilege to conduct mining operations in Ontario. However, the opinion also notes that the Province is constitutionally unable to impose a royalty on mineral production from private land.

  A mineral royalty is generally a payment (1) based on a fixed percentage of production (whether in cash or in kind), or a share of net profits from production, received by a person with a right to the minerals in place; (2) for permitting another to extract and take those minerals; and (3) payable only from the minerals produced or the proceeds derived from the disposition of those minerals. Therefore, the holder of a royalty interest has an economic interest in the natural resources in place, (Palmer v. Bender, 287 U.S. 551, 557 (1933), XII-1 C.B. 235 (1933), and is subject to the inherent risks of mining. United States. v. White, 401 F.2d 610 (10th Cir. 1968); Rev. Rul. 82- 221, 1982-2 C.B. 113; the holder would then qualify for the depletion allowance.

  In the instant case, the Province of Ontario retained no rights to any mineral mined or income therefrom and did not participate in any mining risks. Furthermore, the mining tax imposed on mineral production does not result in acquisition of a right to a specified share of the mineral in place or income derived solely from its extraction. The payment of the tax is not made to the holder of any interest in the minerals in place. Therefore, Ontario does not hold an economic interest in the property and the tax received is not a share of the proceeds from the mineral extracted.

HOLDING

  The payments made under the Ontario Mining Tax Act are not payments of royalties arising out of an economic interest in the minerals in place and, therefore, such amounts are not excludable from the taxpayer's gross income from mining in computing the percentage depletion under the provisions of section 613 of the Code.

Rev. Rul. 85-16, 1985-1 C.B. 180, 1985-8 I.R.B. 7.