Opinion ID: 381301
Heading Depth: 1
Heading Rank: 2

Heading: percentage depletion deduction and proportionate profits method

Text: 7 The percentage depletion deduction provided by Section 613 is calculated by multiplying gross income from mining by the applicable rate. 3 If taxpayer mined his mineral and sold it in crude form at the mine, his gross income from mining would simply be his gross sales price. However, when a taxpayer uses his crude mineral in a manufacturing operation, he has no sales price for the mineral itself. The sales price of the manufactured product cement in this case cannot be used, because to do so would give the taxpayer an inflated deduction based on the price of the manufactured product, which includes the value of the crude mineral plus the value added by the manufacturing processes. The purpose of the percentage depletion deduction is to compensate a taxpayer for the exhaustion of his mineral, not for the exhaustion of his manufactured product. Therefore, the deduction is a percentage of gross income from mining rather than gross income from manufacturing. When the only sales price is a sale of a manufactured product, the problem is how to calculate gross income from mining. If the mineral were sold in crude form by other persons or corporations, there might be a representative market price for the mineral which could be used. Where there is no representative market price, as in this case, the regulations 4 require the use of the proportionate profits method. This method apportions the gross income from the manufactured product between the mining phase and the manufacturing or nonmining phase in proportion that mining costs bear to total costs. 5 The formula is expressed as follows: 8 By apportioning gross income on the basis of the ratio of mining costs to total costs, the formula assumes that each item of cost produces a pro rata share of the profits. 9 Under the proportionate profits method, one crucial determination is ascertaining which are mining costs, and which are not. As a general matter, that determination is controlled, in the case of cement, by Section 613(c)(4) (F). That section provides: 10 (4) Treatment processes considered as mining. The following treatment processes where applied by the mine owner or operator shall be considered as mining to the extent they are applied to the ore or mineral in respect of which he is entitled to a deduction for depletion under section 611: 11 (F) in the case of calcium carbonates and other minerals when used in making cement all processes (other than preheating of the kiln feed) applied prior to the introduction of the kiln feed into the kiln, but not including any subsequent process; 12 The statute provides that some treatment processes are considered part of mining. In the case of cement, the statute provides, and the parties agree, that mining includes all processes applied prior to the introduction of the kiln feed into the kiln, but does not include any subsequent process. This point at which the mining phase ceases and the manufacturing or nonmining phase begins is called the cutoff point. 6 In the first issue of the instant case, discussed in Part III, we are concerned with the proper treatment of certain costs incurred after the cutoff point. 13 The proportionate profits method begins with the sales price or gross income from the manufactured product (cement) and arrives at a constructive figure for the sales price of the mineral, namely, gross income from mining. In this way the taxpayer is allowed a deduction based upon gross income attributable to his mining operations. It is apparent that the proportionate profits method includes within gross income from mining all mining costs and the pro rata profits attributable thereto, and, conversely, excludes from gross income from mining all nonmining costs and the pro rata profits attributable thereto. 14 In this opinion we sometimes refer to gross income from mining as taxpayer's depletable base, since taxpayer is entitled to a percentage depletion deduction based on gross income from mining. 15