REVENUE RULE 90-62

1990-2 C.B. 158, 1990-31 I.R.B. 4.

Internal Revenue Service
Revenue Ruling

NATURAL GAS SOLD AFTER REMOVAL FROM THE PREMISES FOR LESS THAN THE RMFP

Published: July 30, 1990

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

(See Also Section 613; 1.613-3.)

Natural gas sold after removal from the premises for less than the RMFP. If gas is sold after it is removed from the premises, for a price that is lower than the representative market or field price (RMFP), gross income from the property for purposes of the allowance for percentage depletion is determined without regard to the RMFP.

ISSUE

If gas is sold after it is removed from the premises for a price that is lower than the representative market or field price (RMFP), is 'gross income from the property' the RMFP for purposes of the allowance for percentage depletion under section 613A of the Internal Revenue Code?

FACTS

X owns an operating interest in a gas producing reservoir. In 1988, X sold its gas on a delivered basis under long-term fixed price contracts. Because the gas was transported from the well before it was sold, for purposes of calculating its depletion deduction, X determined its gross income from the property based on the RMFP. The RMFP exceeded the contract price; consequently, X claimed a greater depletion allowance than it could have claimed had it used the contract price in computing its gross income from the property.

LAW AND ANALYSIS

For years after 1974, section 613(d) of the Code provides that in the case of oil and gas wells the allowance for depletion shall be computed without reference to section 613, except as provided in section 613A.

Section 613(a) of the Code provides that, except as provided in section 613A, the allowance for depletion under section 611 of the Code with respect to any oil or gas wells shall be computed without regard to section 613. However, under section 613A(b), the allowance for depletion under section 611 shall be computed in accordance with section 613 when natural gas is sold pursuant to a fixed contract.

Section 613(a) of the Code provides generally for an allowance for percentage depletion in the case of mines, wells, and other natural deposits equal to a specified percentage of the gross income from the property, excluding an amount equal to any rents or royalties paid or incurred by the taxpayer in respect of the property.

Section 1.613-3(a) of the Income Tax Regulations provides generally that in the case of oil and gas wells, 'gross income from the property,' as used in section 613(c)(1) of the Code, means the amount for which the taxpayer sells the oil or gas in the immediate vicinity of the well. However, if the oil or gas is not sold on the premises but is manufactured or converted into a refined product prior to sale, or is transported from the premises prior to sale, the gross income from the property shall be assumed to be equivalent to the representative market or field price of the gas before conversion or transportation.

The premise underlying the use of the RMFP is that, when oil or gas is either processed or refined prior to sale, or is transported from the premises prior to sale, its value is increased. Under these circumstances, the sales price of the oil or gas will exceed the gross income from the property. Thus, under the regulations, the RMFP is established as a ceiling on the income that the taxpayer may take into account for depletion purposes.

In the present case, however, the contract price for the delivered gas was less than the RMFP. Under these facts, the ceiling established by the RMFP is not relevant to the determination of the gross income from the property.

Moreover, it is well established that a producer is not entitled to an allowance for depletion based on gross income from the property that exceeds the price the producer actually receives. In United States v. Henderson Clay Products, 324 F.2d 7 (5th Cir. 1963), the taxpayer, an integrated clay mining and brick manufacturer, claimed percentage depletion based on the market price of shredded ball clay, which was in excess of the price for which the taxpayer sold its finished brick. The court differentiated between gross income in excess of income actually received and 'hypothetical' gross income in excess of the actual gross income, noting that at no time was the taxpayer's actual gross income, unreduced by expenses incurred in production and selling, the higher market price of the shredded ball clay. The court consequently denied the taxpayer an allowance for depletion based on the market price of shredded ball clay.

Henderson Clay Products relies in part on Crews v. Commissioner, 89 F.2d 412 (10th Cir. 1937), in which the court noted that 'income from the property is a gain, a profit, something of exchangeable value derived from the property, that is received or drawn by the recipient (the taxpayer) for his separate use, benefit and disposal.' 89 F.2d at 415. The court further noted that to allow a deduction on the basis of income never received and therefore no part of the gross income, on the net part of which a tax is exacted would be manifestly unfair. . . . there should not be included in such gross income proceeds of oil never received by the taxpayer and no part of which became subject to income taxation. 89 F.2d at 416.

In the present case, X may not claim an allowance for percentage depletion based on the RMFP because this would allow a deduction calculated with respect to gross income that X never received.

HOLDING

If gas is sold after it is removed from the premises, for a price that is lower than the RMFP, gross income from the property for purposes of the allowance for percentage depletion is determined without regard to the RMFP.

DRAFTING INFORMATION

The principal author of this revenue ruling is Brenda M. Stewart of the Office of Assistant Chief Counsel (Passthroughs and Special Industries). For further information regarding this revenue ruling contact Brenda M. Stewart on (202) 566-4919 (not a toll-free call).

Rev. Rul. 90-62, 1990-2 C.B. 158, 1990-31 I.R.B. 4.