REVENUE RULE 93-26

1993-1 C.B. 50, 1993-15 I.R.B. 5.

Internal Revenue Service
Revenue Ruling

INTEGRATED OIL COMPANIES; AMORTIZATION OF INTANGIBLE DRILLING AND DEVELOPMENT COSTS

Published: April 12, 1993

§ 291. Special Rules Relating to Corporate Preference Items

(See Also Sections 263, 612, 1254; 1.612-4.)

Integrated oil companies; amortization of intangible drilling and development costs. A taxpayer that has begun amortizing intangible drilling and development costs (IDC) under § 291(b) of the Code must continue to amortize any undeducted IDC if the taxpayer ceases to be an integrated oil company in a later year. If the taxpayer disposes of the property during the amortization period, the unamortized IDC amount is included in basis. See Rev. Rul. 93-26, below.

Integrated oil companies; amortization of intangible drilling and development costs. A taxpayer that has begun amortizing intangible drilling and development costs (IDC) under § 291(b) of the code must continue to amortize any undeducted IDC if the taxpayer ceases to be an integrated oil company in a later year. If the taxpayer disposes of the property during the amortization period, the unamortized IDC amount is included in basis.

ISSUES

(1) If an integrated oil company elects under § 263(c) of the Internal Revenue Code to expense intangible drilling and development costs (IDC) and, pursuant to § 291(b), begins to amortize 30 percent of the IDC over a 60-month period, is the taxpayer required to continue to amortize the IDC if the taxpayer ceases to be an integrated oil company in a later year?

(2) If an integrated oil company has begun amortizing an amount of IDC pursuant to § 291(b) of the Code and during the 60-month amortization period disposes of the property with respect to which the IDC amount was paid or incurred, is the taxpayer required to continue to amortize the IDC?

FACTS

Issue 1. X, a corporation, is a producer of oil and natural gas that files its federal income tax return on a calendar year basis. In year 1, X operated two refineries. Each refinery had a capacity of 40,000 barrels. X's combined refinery runs exceeded 50,000 barrels on at least one day during year 1.

In November of year 1, X incurred $1,000,000 of IDC in drilling domestic oil and gas wells. X elected under § 263(c) of the Code to expense the IDC. On its federal income tax return for year 1, X deducted $700,000 of the IDC pursuant to § 263(c) and $10,000 of the remaining $300,000 of IDC pursuant to § 291(b)(2).

On December 31 of year 1, X sold one of its refineries. X's remaining refinery had runs of no more than 40,000 barrels on any day during year 2. X's retail sales of oil, natural gas, and products derived therefrom, did not exceed $5,000,000 in year 2.

Issue 2. Y, a corporation, is a producer of oil and gas that files its returns on a calendar year basis. In both year 1 and year 2, Y's retail sales of oil, natural gas, and products derived therefrom exceeded $5,000,000.

In September of year 1, Y incurred $2,000,000 of IDC with respect to an oil and gas property. Y elected under § 263(c) of the Code to expense the IDC. On its federal income tax return for year 1, Y deducted $1,400,000 of the IDC pursuant to § 263(c) and $40,000 pursuant to § 291(b)(2). In January of year 2, Y sold the property.

LAW

IDC are capital expenditures; however, § 263(c) of the Code provides that taxpayers have the option to expense IDC currently. The option to expense IDC does not apply to any costs for which any deduction is allowed under § 59(e) or § 291.

§ 1.612-4(a) of the Income Tax Regulations provides that in accordance with the provisions of § 263(c) of the Code, IDC incurred by an operator in the development of oil and gas properties may at the operator's option be chargeable to capital or expense.

§ 291(b)(1)(A) of the Code requires an integrated oil company to reduce its IDC deduction by 30 percent. Under § 291(b)(2), the disallowed amount must be deducted ratably over the 60-month period beginning with the month in which the IDC are paid or incurred. § 291(b)(5) provides that "[t]he portion of the adjusted basis of any property which is attributable to [IDC] shall not be taken into account for purposes of determining depletion under § 611."

By cross reference to § 613A(d)(2) and (4) of the Code, § 291(b)(4) defines an integrated oil company as a taxpayer, whose combined gross receipts (or those of a related person) from retail sales of oil, natural gas, or any product derived therefrom, for the taxable year exceed $5,000,000 or whose refinery runs (or those of a related person) exceed 50,000 barrels on any day during the taxable year.

§ 291(b) of the Code applies only to "integrated oil companies." A taxpayer's status as an integrated oil company is determined annually under § 613A(d) based on the taxpayer's retail sales or refinery runs for that year. Consequently, a taxpayer that is an integrated oil company in the year IDC are paid or incurred may not be an integrated oil company in a subsequent taxable year if in that year (1) the taxpayer's retail sales of oil, natural gas, or derivative products do not exceed $5,000,000, or (2) there is no day on which the taxpayer's refinery runs exceed 50,000 barrels.

ANALYSIS

Issue 1. X was an integrated oil company in year 1 because X's refinery runs exceeded 50,000 barrels for at least one day during the taxable year. However, X was not an integrated oil company in year 2 because there was no day in that year on which X's refinery runs exceeded 50,000 barrels and X's retail sales of oil, natural gas, or products derived therefrom did not exceed $5,000,000 for the taxable year.

§ 291(b) of the Code applies if a taxpayer is an integrated oil company in the year the IDC are paid or incurred. § 291(b) makes no provision for the accelerated deduction of unamortized IDC if, because of a reduction in retail sales or refinery runs, the taxpayer ceases to be an integrated oil company in a subsequent taxable year. The accounting treatment of IDC under § 291(b) is determined in the year the IDC are paid or incurred, and there is no authority to change that treatment as long as the taxpayer continues to own the property to which the IDC relate. Consequently, if a taxpayer is an integrated oil company in the year IDC are paid or incurred, the taxpayer must amortize 30 percent of the IDC over the 60-month period beginning with the month in which the IDC were paid or incurred without regard to whether the taxpayer is an integrated oil company in a subsequent taxable year.

In this case, X had $290,000 of unamortized IDC at the beginning of year 2. Because X was an integrated oil company in year 1, the year the IDC were paid or incurred, X must amortize the $290,000 of unamortized IDC over the remainder of the 60-month period notwithstanding the fact that X is not an integrated oil company in year 2.

Issue 2. Y was an integrated oil company in year 1 and year 2 because in each year Y's retail sales of oil, natural gas, and products derived therefrom exceeded $5,000,000. Y properly deducted a portion of the IDC incurred in year 1 and began amortizing the remainder under § 291(b)(2) of the Code. However, because in year 2 Y disposed of the property for which it was amortizing the IDC, it is necessary to determine whether Y must continue to amortize that IDC.

§ 291 of the Code does not explicitly state whether any unamortized IDC should be included in basis if a mineral property is disposed of. However, implicit in the language of § 291(b)(5) is that unamortized IDC are treated as a portion of the property's basis, albeit a portion that is not subject to cost depletion.

Therefore, upon the disposition of the oil and gas property, Y includes the unamortized portion of the IDC ($560,000) in the basis of the property for purposes of computing gain or loss upon the disposition. Recapture of the IDC under § 1254 of the Code is determined based on the gain so computed and the IDC actually deducted ($1,400,000). Accordingly, Y does not continue amortizing the IDC incurred with respect to the property even though Y remains an integrated oil company.

HOLDINGS

(1) If an integrated oil company elects under § 263(c) of the Code to deduct IDC currently and pursuant to § 291(b) begins to amortize 30 percent of the IDC over a 60-month period, the taxpayer must continue to amortize any undeducted IDC even though the taxpayer ceases to be an integrated oil company during the 60-month period.

(2) If an integrated oil company has begun amortizing an amount of IDC pursuant to § 291(b) of the Code and during the 60-month amortization period disposes of the property with respect to which the IDC amount was paid or incurred, the unamortized portion of the IDC amount is included in basis for purposes of determining gain or loss upon the disposition and is not subject to continued amortization.

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) 622-3120 (not a toll-free number).

Rev. Rul. 93-26, 1993-1 C.B. 50, 1993-15 I.R.B. 5.