REVENUE RULE 93-46

1993-2 C.B. 3, 1993-25 I.R.B. 6.

Internal Revenue Service
Revenue Ruling

§ 29 CREDIT; ROYALTY OWNERS

Published: July 19, 1993

§ 29. Credit for Producing Fuel from a Nonconventional Source

(See Also Sections 11, 14; 1.611-1, 1.614-1.)

§ 29 credit; royalty owners. The owner of a royalty interest is allowed an allocable share of the credit provided in § 29 of the Code where the mineral in which the royalty owner has an interest is a qualified fuel when extracted.

ISSUE

Is the owner of a royalty interest allowed an allocable share of the credit provided in § 29 of the Internal Revenue Code for producing fuel from a nonconventional source?

FACTS

In 1991, A, a fee interest owner, enters into a mineral lease agreement with X for the development of a natural gas property. The lease agreement provides for the assignment of all operating rights to X. A retains a 1/8 royalty interest. X drills wells that in 1992 produce 560x mcf of gas from a tight formation. X sells the 560x mcf of gas to an unrelated person for $800x. X retains $700x ($800x x 7/8) as proceeds from the sale of the production attributable to the operating mineral interest and pays A $100x ($800x x 1/8) as proceeds from the sale of the production attributable to A's royalty interest.

LAW AND ANALYSIS

§ 29(a) of the Code provides a credit for qualified fuels produced by a taxpayer and sold to an unrelated person during the taxable year.

§ 29(c)(1) of the Code defines the term "qualified fuels" to include gas produced from a tight formation.

§ 29(d)(3) of the Code provides that in the case of a property or facility in which more than one person has an interest, production from the property or facility (as the case may be) is allocated among the persons in proportion to their respective interests in the gross sales from the property or facility.

§ 29(f) of the Code provides that the credit applies only to qualified fuels that are produced from a well drilled after December 31, 1979, and before January 1, 1993, or produced in a facility placed in service after December 31, 1979, and before January 1, 1993, and that are sold before January 1, 2003.

§ 1.611-1(b)(1) of the Income Tax Regulations provides that an economic interest is possessed in every case in which the taxpayer has acquired by investment any interest in mineral in place and secures, by any form of legal relationship, income derived from the extraction of the mineral, to which the taxpayer must look for a return of the taxpayer's capital.

§ 1.614-1(a)(2) of the regulations provides that the term "interest" means an economic interest in a mineral deposit within the meaning of § 1.611-1(b)(1). The term includes working or operating interests, royalties, overriding royalties, net profits interests, and, to the extent not treated as loans under § 636 of the Code, production payments.

§ 29(d)(3) requires allocation of the production of qualified fuels when more than one person has an interest in a property. The allocation is based on each taxpayer's right to share in the gross sales of qualified fuels from the property.

Gas produced from a tight formation is a qualified fuel under § 29(c) of the Code. A owns a royalty interest in the tight formation gas and X owns an operating mineral interest. A's royalty interest and X's operating interest entitle A and X to a share of the proceeds derived from the sale of the tight formation gas. Therefore, both A and X are entitled to claim the credit provided in § 29 on their respective shares of production. Pursuant to § 29(d)(3), the production is allocated between A and X in proportion to their interests in the gross sales of the gas. Accordingly, 490x mcf (560x mcf x 7/8) of the gas is allocated to X and 70x mcf (560x mcf x 1/8) of the gas is allocated to A.

HOLDING

The owner of a royalty interest is allowed an allocable share of the credit provided in § 29 of the Code where the mineral in which the royalty owner has an interest is a qualified fuel when extracted.

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 call).

Rev. Rul. 93-46, 1993-2 C.B. 3, 1993-25 I.R.B. 6.