Rev. Rul. 86-83

1986-1 C.B. 251, 1986-25 I.R.B. 5.

DEVELOPMENT EXPENDITURES; OVERBURDEN REMOVAL IN OPEN PIT MINING

Published: June 23, 1986

Section 616.-Development Expenditures 26 CFR 1.616-1:  Development expenditures.

  Development expenditures; overburden removal in open pit mining. The removal of overburden in open pit mining makes it possible to mine underlying ore. Accordingly, the cost of removing such overburden is incurred for the development of the mine and is currently deductible under section 616 of the Code. Rev. Rules 67-169 and 77-308 distinguished

ISSUE

  Whether the costs of removing over-burden or waste incurred at taxpayer's open pit mines are development expenditures under section 616 of the Internal Revenue Code.

FACTS

  Taxpayer owns mineral properties consisting of steeply dipping tabular ore bodies. It extracts ore from these bodies by 'open pit' mining. To obtain access to the ore taxpayer must remove the overlying overburden or waste. In order to avoid cave-ins, the sides of an open-pit mine must be sloping, not vertical, and thus, the area of the pit must be expanded as the mine becomes deeper. In anticipation of mining ore at greater depths, the taxpayer estimates the dimensions of a pit necessary to mine the entire ore deposit. It removes the overburden or waste in layers according to the projected dimensions of the pit that will exist when mining is complete. By this method of operation, removal of the overburden or waste not only facilitates mining the first layer or ore, but also allows eventual access to the additional lower benches of ore, some of which are not directly below the ore currently being mined. Thus, such removal is not related to the rate of extraction of the mineral in the day-to- day mining cycle; it provides long-term benefits for the entire mineral deposit by making it possible to reach the entire deposit.

LAW AND ANALYSIS

  Section 616(a) of the Internal Revenue Code provides that there shall be allowed as a deduction in computing taxable income all expenditures paid or incurred during the taxable year for the development of a mine after the existence of commercially marketable quantities of minerals has been disclosed.

  Section 1.616-1(a) of the Income Tax Regulations states that development expenditures are deductible whether the expenditures were made in the development or production stage of the mine.

  In Rev. Rul. 77-308, 1977-2 C.B. 208, a 100-acre tract was subdivided into five 20-acre subtracts for strip mining. The overburden was stripped, and the coal was estracted, from each subtract separately. The revenue ruling holds that the costs of stripping the overburden are not development expenditures, but are operating costs because the stripping is so integrally related to extraction of a limited area of the coal to be mined.

  Expenditures incurred in the stripping of overburden from a horizontal limestone deposit are held to be a cost of goods sold in Rev. Rul. 67-169,

1967-1 C.B. 159. In that revenue ruling, the expenditures are not development expenditures because each increment of overburden benefits only a particular segment of mineral. Thus, expenditures to remove overburden were incurred on a continuing basis, and the rate at which overburden was stripped is directly related to the rate at which mineral was extracted. The fact that the

overburden may have been stripped months prior to extraction of the mineral was not determinative.

  In the present situation, the taxpayer's 'development operations' are excavations performed for the purpose of preparing the entire ore body, or a substantial part of it, for extraction. Development expenditures are incurred for the purpose of making the ore accessible for sustained extraction and are recoverable over a relatively long period.

  Section 1.616-1(a) of the regulations states that development expenditures may be incurred during the production state of the mines. Therefore, the issue is whether the costs of removing the overburden or waste are operating costs or development costs. In Rev . Ruls. 67-169 and 77-308, both of which concern a strip mining operation, the removal of overburden permitted extraction of only the portion of the mineral directly beneath the overburden, and thus the removal was directly related to the rate of extraction of the mineral in the day-to-day mining cycle. In the present situation, which concerns an open pit mining operation, removal of the overburden or waste makes both the ore directly below it and remaining lower levels of ore available for mining. The removal of the overburden or waste is not related to the rate of extraction of the mineral in the daily mining cycle.

  Development expenditures are described in Rev. Rul. 67-169 as expenditures paid or incurred to make the ore accessible for sustained extraction over a relatively long period. The removal of overburden or waste by the taxpayer in this case will make it possible to mine additional ore from lower levels of the pit over a relatively long period. Exependitures for such removal will benefit the extraction of the entire ore body or a substantial portion thereof.

HOLDING

  The costs of removing overburden or waste incurred at taxpayer's open pit mines are development expenditures under section 616(a) of the Code.

EFFECT ON OTHER REVENUE RULINGS

  Rev. Ruls. 67-169 and 77-308 are distinguished.

Rev. Rul. 86-83, 1986-1 C.B. 251, 1986-25 I.R.B. 5.