revrul92-72

REVENUE RULE 92-72

1992-2 C.B. 118, 1992-37 I.R.B. 5.

Internal Revenue Service
Revenue Ruling

PERCENTAGE DEPLETION; RETAILERS EXCLUSION

Published: September 14, 1992

Section 613A. Limitations on Percentage Depletion in Case of Oil and Gas Wells, 26 CFR 1.613A-7: Definitions.

(See Also Section 613; 1.613-1.)

Percentage depletion; retailers exclusion. This ruling describes the circumstances under which a taxpayer is not considered to be selling oil or natural gas through a related retailer and therefore is not considered a retailer itself for purposes of section 613A(d)(2) of the Code.

ISSUE

Is a taxpayer considered to be selling oil or natural gas through a related retailer, and therefore considered a retailer itself for purposes of Section 613A(d)(2) of the Internal Revenue Code if:

(1) the taxpayer does not own a significant ownership interest in the retailer;
(2) the taxpayer sells its production to persons unrelated to the taxpayer and unrelated to the retailer;
(3) the retailer does not purchase oil or natural gas from the taxpayer's customers or persons related to the taxpayer's customers;
(4) there are no arrangements whereby the retailer acquires for resale oil or natural gas that the taxpayer produced or made available for purchase by the retailer; and
(5) neither the taxpayer nor the retailer knows or controls the final disposition of the oil or natural gas sold by the taxpayer or the original source of the petroleum products acquired for resale by the retailer?

FACTS

X, a holding company, owns all of the outstanding stock of Y and all of the outstanding stock of Z. Y owns working interests and royalty interests in several oil and gas leases in state M. Y sells its production at posted prices to parties unrelated to X, Y, or Z. Y has no way of knowing or controlling what happens to its oil and natural gas after it is sold.

Z is engaged in the marketing of products derived from oil and natural gas through retail outlets in state N. Z purchases these products in arm's length transactions from parties who are unrelated to X, Y, Z, or the customers of Y. Z purchases petroleum products for resale from numerous suppliers and has no knowledge of, or control over, their original source. Z's gross receipts from the retail sales of oil, natural gas, and derivative products (excluding bulk sales) exceed $5,000,000 annually. There are no arrangements, express or implied, whereby Z acquires for resale oil or natural gas that Y produced or caused to be made available for acquisition by Z.

LAW AND ANALYSIS

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

Section 613A(c)(1) of the Code provides that, except as provided in s 613A(d), the allowance for depletion under s 611 shall be computed in accordance with s 613 with respect to so much of the taxpayer's average daily production as does not exceed the taxpayer's depletable oil quantity and so much of the taxpayer's average daily production as does not exceed the taxpayer's depletable natural gas quantity.

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

Section 613A(d)(2) of the Code provides that s 613A(c) does not apply in the case of any taxpayer ("retailer") who directly, or through a related person, sells oil or natural gas (excluding bulk sales of such items to commercial or industrial users), or any product derived from oil or natural gas (excluding bulk sales of aviation fuels to the Department of Defense)--

(A) through any retail outlet operated by the taxpayer or a related person, or
(B) to any person

(i) obligated under an agreement or contract with the taxpayer or a related person to use a trademark, trade name, 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) does not apply in any case in which the combined gross receipts from the sale of oil, natural gas, or any product derived therefrom, for the taxable year of all retail outlets taken into account do not exceed $5,000,000.

Section 1.613A-7(r)(2) of the regulations provides, in part, that a taxpayer shall be deemed to be selling oil or natural gas (or a product derived therefrom) through a related person in any case in which any sale of oil or natural gas (or a derivative product) by the related person produces gross income from which the taxpayer may benefit by reason of the taxpayer's direct or indirect ownership interest in the related person. Moreover, a taxpayer is deemed to be selling oil or natural gas (or a derivative product) through a retail outlet operated by a related person in any case in which a related person who operates a retail outlet acquires for resale oil or natural gas (or a derivative product) which the taxpayer produced or caused to be made available for acquisition by the related person pursuant to an arrangement whereby some or all of the taxpayer's production is marketed.

It follows that a taxpayer should be treated as selling oil or natural gas (or a derivative product) through a related person in any case in which the taxpayer knows or has reason to believe that the taxpayer's oil or natural gas is or will be commingled with other producers' oil or natural gas that is or may be acquired for resale by the related person. See Rev.Rul. 85-12, 1985-1 C.B. 181.

In the present case, Y is a producer of oil and natural gas. Y and Z are related persons within the meaning of s 613A(d)(3) of the Code because 5 percent or more in value of the outstanding stock of both Y and Z is owned by a third person, X. Z's annual retail sales of petroleum products (excluding bulk sales) exceed $5,000,000; therefore, Z is a retailer within the meaning of s 613A(d)(2). Y will be precluded under s 613A(d)(2) from taking a deduction for percentage depletion if Y sells the oil or natural gas it produces through any of the retail outlets operated by Z.

Y sells the oil and natural gas it produces into the stream of commerce to multiple purchasers at market prices. Y has no knowledge of, or control over, what happens to the oil and natural gas it produces after it is sold. Z purchases petroleum products for resale from numerous suppliers and has no knowledge of, or control over, the original source of the petroleum products it purchases. There are no arrangements, express or implied, whereby Z acquires for resale oil or natural gas that Y produced or caused to be made available for acquisition by Z. Under these circumstances, for purposes of s 613A(d)(2) of the Code, Y is not considered to be selling oil, natural gas, or products derived from oil or natural gas through any of the retail outlets operated by Z.

HOLDING

A taxpayer is not considered to be selling oil or natural gas through a related retailer for purposes of s 613A(d)(2) of the Code if:

Rev. Rul. 92-72, 1992-2 C.B. 118, 1992-37 I.R.B. 5.