Rev. Rul. 85-79

1985-1 C.B. 337, 1985-24 I.R.B. 13.

WINDFALL PROFIT TAX; NET INCOME LIMITATIONS; TREATMENT AS DIRECT EXPENSE;

ALLOCATING OVERHEAD COSTS

Published: June 17, 1985

Section 4988.-Windfall Profit; Removal Price

(Also Section 613:  26 CFR 1.613-5.)

  Windfall profit tax; net income limitations; treatment as direct expense; allocating overhead costs. In computing the net income limitation on windfall profit tax, a taxpayer may not include windfall profit tax as a direct expense for purposes of allocating overhead costs to producing properties.

ISSUE

  Whether, in computing the net income limitation (NIL) on windfall profit tax  (WPT), a taxpayer may include the WPT as a direct expense for purposes of allocating overhead costs to producing properties.

LAW AND ANALYSIS

  Section 4986 of the Internal Revenue Code imposes an excise tax on the windfall profit from taxable crude oil removed from the premises during each taxable period.

  Section 4988(b)(1) of the Code provides that the windfall profit on any barrel of crude oil shall not exceed 90 percent of the net income attributable to such barrel. Under section 4988(b)(2), the net income attributable to a barrel is determined for the taxable year by dividing the taxable income from the property attributable to taxable crude oil by the number of barrels of taxable crude oil from such property.

  Section 4988(b)(3) of the Code provides, in part, that the taxable income from the property shall be determined under section 631(a); however, no deduction shall be allowed for the tax imposed by section 4986.

  Section 613(a) of the Code allows percentage depletion based on the gross income from the property in the case of mines, wells, and other natural deposits listed in section 613(b). Such allowance shall not exceed 50 percent of the taxpayer's taxable income from the property (computed without allowance for depletion).

  Section 1.613-5(a) of the Income Tax Regulations provides that the term  'taxable income from the property' means gross income from the property less all allowable deductions which are attributable to mining processes, including mining transportation, with respect to which depletion is claimed. Where a taxpayer has more than one property, deductions that are not directly attributable to a specific mineral property shall be properly apportioned among the several properties.

  The direct expense method of allocating overhead means simply that overhead is divided among the properties in proportion to the direct expenses attributable to each property. The direct expense method assumes that as direct costs increase, indirect costs increase proportionately. Thus, the higher the direct costs of producing oil on a property the greater the proportion of overhead that is allocated to that property. Where a significant direct cost, like WPT, bears little, if any, relation to the indirect costs associated with oil production, the direct expense method would not result in a proper apportionment of overhead costs.

  When Congress enacted the WPT, the NIL was included to insure that no property would be taxed to the extent that production would not be profitable. In determining the net income attributable to a barrel of crude oil for purposes of limiting the amount of WPT that may be applied against the net income, it is logically necessary to exclude the WPT itself. Congress so excluded it from the NIL calculation in section 4988(b)(3)(B)(ii). See S. Rep. No. 96-394, 96th Cong., 1st. Sess. 58 (1979). 1980-3 C.B. 131, 176; and H.R. Rep. No. 96-304, 96th Cong., 1st Sess. 37(1979), 1980-3 C.B. 81, 119.

  The effect of treating WPT as a direct expense for purposes of allocating overhead expenses would be inconsistent with the requirement of section 4988(b) that no deduction for windfall profit is allowed in computing taxable income from the property. If WPT would be included as a direct expense, more overhead would be allocated to properties with high WPT, thereby lowering the taxable income from these properties, which, in turn, would lower their net income and, therefore, their WPT. Thus, including WPT as a direct expense would be inconsistent with Congressional intent that the WPT not influence the computation of taxable income for NIL purposes. Under these circumstances, overhead would not be properly apportioned among properties as required by section 1.613-5(a) of the regulations.

HOLDING

  In computing the NIL on WPT, a taxpayer may not include WPT as a direct expense for purposes of allocating overhead costs to producing properties.

Rev. Rul. 85-79, 1985-1 C.B. 337, 1985-24 I.R.B. 13.