Court Opinion

ID: 4484294
Source: CourtListenerOpinion
Date Created: 2020-01-16 21:16:38.781325+00
Date Added: 2024-06-11T07:58:23.813695
License: Public Domain

Goffe, J., dissenting: I respectfully dissent. Section 631(c) and related provisions of the Internal Revenue Code, as well as an established body of case law, mandate a holding in petitioners’ favor on the first issue in this case. I dissent for the following separate and distinct reasons: (1) The treatment of royalties paid by Cumberland to the coal owners, as approved by the majority and reflected in the example in section 1.631 — 3(b)(3)(ii)(6), Income Tax Regs., is incorrect and inconsistent with section 631 of the Internal Revenue Code and the body of section 1.631-3(b)(3)(ii)(a), Income Tax Regs., and, (2) The body of section 1.631-3(b)(3)(ii)(a), Income Tax Regs., is invalid because it is contrary to section 631 of the Internal Revenue Code, is unsupported by legislative history, and is contrary to the generally accepted principles of taxation of natural resources. I. Background The law regarding the tax treatment of royalties paid and received in a mineral lease transaction is well settled. It was long ago held that the dominant characteristic of a mineral lease transaction is the acquisition by the lessee of the privilege of exploiting the lessor’s land for the production of minerals and that the passage of title to the minerals was incidental to the transaction. Burnet v. Harmel, 287 U.S. 103 (1932). Thus, payments made pursuant to the lease are in the nature of rent. As such, they are generally deductible by the lessee under section 62(5) and either section 162(a)(3) or section 212, and are includable in the lessor’s gross income. The traditional treatment of royalties paid to a lessor is that they are taxable income subject to depletion. Palmer v. Bender, 287 U.S. 551 (1933). Similarly, lease bonuses (amounts paid by a lessee to a lessor upon the execution of a lease, which amounts are not affected by the presence or absence of production from the leaseholds) have been characterized, with regard to the lessor, as mere advance royalties which also are includable in the lessor’s taxable income subject to depletion. Herring v. Commissioner, 293 U.S. 322 (1934); G.C.M. 22730, 1941-1 C.B. 214. A lessee, on the other hand, though he may deduct from gross income royalties paid pursuant to a mineral lease, is required to capitalize lease bonuses paid and other costs of acquiring the lease and recover such amounts through the depletion deduction. Canadian River Gas Co. v. Higgins, 151 F.2d 954 (2d Cir. 1945). The fine line between installment bounuses and advanced royalties paid by a lessee must often be drawn, because bonus payments must always be capitalized, while advanced royalties may be deducted, at the option of the lessee, either when paid or when the mineral product in respect of which the advanced royalties were paid or accrued is sold. Sec. 1.612-3(b)(3), Income Tax Regs. Here, such a line need not be drawn because it has been stipulated that the payments before us were royalties. Since on its returns the partnership elected to deduct such royalties when paid, petitioners may treat their allocable shares of such payments as royalties paid by them. Sec. 702(a)(7). It can, therefore, be seen that, absent any consideration of section 631(c), the royalties paid by Cumberland, the partnership, are clearly deductible from the gross income of its partners, and the royalties received by Cumberland would flow through to its partners as ordinary income subject to depletion. Except to the extent that section 631(c) alters this treatment, the Court is bound to compute petitioners’ taxable income under the above-stated, well-settled principles of taxation of profits from extraction of natural resources. Section 631(c) was enacted by Congress in 1951 as a relief measure for the coal industry. S. Rept. 781, 82d Cong., 1st Sess. (1951), 1951-2 C.B. 458, 488. It alters the treatment to be accorded the disposal of a mineral interest for Federal income tax purposes.1 Focusing upon the treatment of a lessor or sublessor, section 631(c) provides that the disposal of coal as involved in this case shall be treated as a sale of coal. Section 1231(b)(2) includes coal as property used in the trade or business of the taxpayer, and thus the provisions of section 1231(a) and section 631(c) allow capital gain or ordinary loss treatment. As an offset to the advantage of reporting coal royalty income at capital gains rates, Congress removed the traditional tax benefit given lessors and sublessors, percentage depletion under section 613. Thus, instead of allowing lessors and sublessors to exhaust the basis of a mineral interest by offsetting ordinary income from mineral royalties with a depletion deduction each year, the cost basis of a mineral interest is offset against the amount realized upon the disposition of the interest. In the instant case, for some unexplained reason, Cumberland claimed no deduction or offset for an aliquot part of adjusted depletion basis. Perhaps it was error on the part of Cumberland or perhaps Cumberland had no costs in acquiring the coal leases or development costs. As will be demonstrated below, however, the body of the regulations treats the royalties paid by Cumberland as costs to be recovered against the coal disposed of, a treatment contrary to the example in the regulations which the Commissioner employed and which the majority of the Court approves. The Commissioner, in his statutory notices of deficiency, adjusted the income and deductions reported by Cumberland with the following explanation: “It is determined that the expenses claimed for advance and earned royalties paid are part of the cost of coal disposed of during the year and, as such, are deductions from capital gain income instead of being deductions from ordinary income as claimed in the partnership returns.” II. Treatment by Commissioner in Statutory Notice and Approval by Majority of the Court The Commissioner adjusted the income of Cumberland (and the shares of its income to its partners) by disallowing Cumberland’s deduction for royalties paid to the owners of the coal and, instead, allowing the royalty payments only as offsets to the royalty income received by Cumberland from Webster Coal. The Commissioner’s determination conforms to the example under section 1.631-3(b)(3)(ii)(6), Income Tax Regs., but that determination is inconsistent with the Code and the body of the regulations and, therefore, invalid. The regulations (not the example) do not provide for an offset of royalties paid against royalties received but, instead, provide that royalties paid by a sublessor are added to the adjusted depletion basis of the coal. Section 1.631-3(b)(3)(ii)(a), Income Tax Regs., provides as follows: However, a lessee who is also a sublessor may dispose of coal or iron ore as an “owner” under section 631(c). Rents and royalties paid with respect to coal or iron ore dispoed of by such a lessee under section 631(c) shall increase the adjusted depletion basis of the coal or iron ore and are not otherwise deductible. [Emphasis added.] The example under section 1.631 — 3(b)(3)(ii)(6), Income Tax Regs., holds as follows: Example. B is a sublessor of a coal lease; A is the lessor; and C is the sublessee. B pays a royalty of 50 cents per ton. C pays B a royalty of 60 cents per ton. The amount realized by B under section 631(c) is 60 cents per ton and will be reduced by the adjusted depletion basis of 50 cents per ton, leaving a gain of 10 cents per ton taxable under section 631(c). The fallacy of the example is that it does not consider that portion of section 631(c) of the Code which prescribes fixing the amount of gain from the sale of coal as “the difference between the amount realized from the disposal of such coal or iron ore and the adjusted basis thereof, plus the deductions disallowed for the taxable year under section 272.” (Emphasis added.) Likewise, the body of the regulations repeats the language of the Code as follows: The difference between the amount realized from the disposal of the coal or iron ore in any taxable year, and the adjusted depletion basis thereof plus the deductions disallowed for the taxable year under section 272, shall be gain or loss upon the sale of the coal or iron ore. [Sec. 1.631-3(aXl), Income Tax Regs. Emphasis added.] By overlooking the term “thereof” in the language quoted above, respondent has resorted in the example to an offset concept which has no support in the law or regulations instead of adding the disallowed deduction to basis to be recovered ratably from the adjusted depletion basis over the useful life of the depleting natural resource. The term “thereof” recognizes that only a portion of the adjusted depletion basis is offset against income in the current year; i.e., that portion which relates to the coal that was sold. I know of no area in the tax law where an item is disallowed as an ordinary deduction, is added to basis and the entire basis of the asset sold, and the asset retained is offset against the gain realized from the sale of only part of the asset. It is a cardinal rule in the tax law that when one sells part of an asset one may offset against the gain from that sale only that portion of the cost basis relating to what was sold. But the Commissioner did not do that in his example or in his determination of Cumberland’s net income. Yet, in his statutory notices of deficiency (language quoted in full above), he determined that the royalties paid by Cumberland were “part of the cost of coal disposed of.” Section 631(c) of the Code and the regulations prohibit the allowance of percentage depletion but they do not prohibit the recovery of costs nor should they do so. Section 631 merely changes the character of the proceeds realized from the sale of coal from ordinary income to capital gain. It neither prohibits nor changes the rule for allowing the owner to recover the basis of what was sold by offsetting it against the selling price. The denial of percentage depletion is required because it is based upon a percentage of proceeds from sale of the mineral, not its cost to the owner. “The depletion unit of coal or iron ore disposed of shall be determined under the rules provided in the regulations under section 611, relating to cost depletion.” Sec. 1.631-3(b)(2), Income Tax Regs. Cost depletion of coal under section 611 and the regulations thereunder is computed as follows: [[Image here]] Sec. 1.611-2(a)(l) and (a)(3), Income Tax Regs. The error of the Commissioner’s determination in this case and the same error contained in the example in his regulations can best be illustrated by a hypothetical. The record in the case is not complete enough to show all the ingredients necessary for applying the regulations such as the number of units expected to be mined; therefore, let me propose the following hypothetical which is within the realm of reason of all the facts. Further, because advance royalties complicate the computations, I shall use only the “earned”2 royalties for the taxable year 1967. In the taxable year 1967, Cumberland paid “earned royalties” to the owners of the coal deposits aggregating $10,723.51. Assume that all of the royalties were paid pursuant to the lease provision of 10 cents per ton (and not to the greater of the advance minimum royalty or 10 cents per ton because such facts cannot be determined from the record). It can be assumed, therefore, for purposes of these computations, that because Cumberland paid 10 cents per ton to the owners of the coal, that Webster Coal mined 107,235 tons of coal. Assume, further, that pursuant to all of the leases, Webster Coal paid Cumberland 30 cents per ton (instead of the possible 8y2 percent of gross sales price because such facts cannot be determined from the record). That would mean that Webster Coal paid royalties to Cumberland in 1967 in the amount of $32,171 (107,235 tons x $0.30 per ton). Assume, further, that the coal reserves aggregated 1 million tons before the operations began in 1967. The following computations reflect (1) how the Commissioner treated the royalties paid by Cumberland pursuant to the example in the regulations and approved by the majority of the Court; (2) how the body of the regulations provide for such treatment; and (3) how Cumberland treated the royalty payments. (1) Treatment by Commissioner, Example in the Regulations, and Majority of the Court Royalties received from sales of coal. $32,171 Less royalties paid by Cumberland to coal owners. 10,724 Long-term capital gain to be reported by partners. 21,447 (2) Treatment Pursuant to Body of the Regulations [[Image here]] (coal reserves at beginning of 1967) Royalties received from sales of coal. 32,171 Less aliquot part of royalties paid by Cumberland characterized as “adjusted depletion basis”. 1,149 Long-term capital gain to be reported by partners. 31,022 (3) Computation Made by Cumberland Royalties received from sales of coal reported in full by partners.$32,171 Royalties paid by Cumberland, allowed in full as deductions by the partners. 10,724 It is readily apparent that the computations made by the Commissioner in his statutory notices of deficiency pursuant to the example in the regulations and approved by the majority of the Court produce a lower income tax liability than a computation made pursuant to the body of the regulations. This may explain why the regulations have remained unchallenged for such a long period of time; i.e., if upheld, the taxpayers would have more to lose. Because the majority of the Court adopts the computations made by the Commissioner pursuant to the example of the regulations, it is disapproving the computation prescribed by the body of the regulations, yet it sustains the validity of the regulations. If the body of the regulations is valid (a point addressed in III below) the percentage of the royalties paid by Cumberland will vary from year to year because the reserves of coal fluctuate with the acquisition of additional leases, and the number of tons of coal mined each year fluctuates. If the body of the regulations is valid, this is obviously the correct manner in which to treat the royalties paid by Cumberland; i.e., an aliquot part of the adjusted depletion basis. If, instead, the majority disapproved the treatment of the royalties paid made by the Commissioner and approved the treatment prescribed by the body of the regulations, the resulting deficiencies in income tax would exceed those determined by the Commissioner in his statutory notices of deficiency. From the explanation and examples provided above, it can be seen that the body of section 1.631-3(b)(3)(ii)(a), Income Tax Regs., is plainly inconsistent with the example used to illustrate it. The Commissioner and the majority have foil wed the example rather than the body of the regulations, but neither has faced up to the distasteful reality that if the example correctly states the application of the law, then the body of the regulations is invalid. Because the validity of the regulations is at issue in this case, there is no excuse which allows us to ignore the plain internal inconsistency of the regulations. Having carefully examined the competing methods of computation under the regulations, I conclude that the treatment of the royalties paid by Cumberland approved by the majority of the Court (under the example in the regulations) is erroneous because it is inconsistent with the Internal Revenue Code and body of the regulations and is unsupported by any statute, rule of law, or regulation. III. Treatment Under Body of Sec. 1.631-3(b)(3)(ii)(a), Income Tax• Regs. Section 631(c) of the Code contains the following provisions: “In determining the gross income, adjusted gross income or the taxable income of the lessee, the deductions allowable with respect to rents and royalties shall be determined without regard to the provisions of this subsection.” That section also provides that a sublessor owns an economic interest in the coal and is, therefore, entitled to the benefits of section 631 in reporting its royalty income. By regulation, the Commissioner, contrary to the admonition in the Code quoted above, denies to a sublessor the deduction for royalties paid which he could unquestionably deduct as a lessee. He performs this unwarranted surgery on the sublessor’s deduction for royalty payments in section 1.631-3(b)(3)(ii)(a), Income Tax Regs.: However, a lessee who is also a sublessor may dispose of coal or iron ore as an “owner” under section 631(c). Rents and royalties paid with respect to coal or iron ore disposed of by such a lessee under section 631(c) shall increase the adjusted depletion basis of the coal or iron ore and are not otherwise deductible. The majority of the Court finds this portion of the regulations valid although, of course, the Commissioner did not apply it in this case, and it is inconsistent with the example in the regulations which the Commissioner applied to Cumberland and of which the majority approves. Before Cumberland subleased the coal lands to Webster Coal it was a lessee, and its deductions for royalties paid to the owners of coal lands would be deductible under section 162(a)(3) of the Code and, furthermore, because section 631(c) of the Code prohibits any adjustments to the lessee’s deductions. It has paid the royalties to the land owners by virtue of its role as a lessee. When Cumberland subleased the coal properties to Webster Coal, it continued to pay royalties to the land owners as the lessee under the leases. It became a sublessor and it received royalties from Webster Coal only in the role of sublessor. The majority, in effect, holds that a sublessor is not a lessee. But a sublessor is a lessee. A sublease contemplates a reversion but an assignment does not. Murphy v. Reynolds, 31 Tenn. App. 94, 212 S.W.2d 686 (1948). None of the leases involved here were assigned. Instead, the lessee (Cumberland) and Webster Coal entered into subleases. The subleases contain no consent of the landowners; therefore, the subleases did not relieve the lessee (Cumberland) of its obligation under the primary leases when it became a sublessor. Accordingly, as a matter of law, Cumberland continued to be a lessee after it became a sublessor. A sublease cannot be supported without a lease. The term “subles-sor” implies the existence of a primary lease. Indeed, the majority holds that Cumberland, in effect, ceased to be a lessee before it subleased the properties because it never intended to nor did it ever engage in mining operations and because all of the leases were at some time assigned, proving somehow that a single transaction transpired. Although the majority, in its opinion, attributes this intent to Cumberland, it makes no such finding of fact, and because the case was fully stipulated, the record will not support such a finding. The majority, in denying the royalty-paid deduction to Cumberland because it is a sublessor, overlooks the fact that the regulations recognize Cumberland as a lessee. Section 1.631-3(b)(3)(ii)(a), Income Tax Regs., quoted above describes a sublessor as “such a lessee.” But if a sublessor is still a lessee, its deductions cannot be changed because of the prohibition of section 631 of the Code quoted above. Section 631(c) of the Code was enacted by Congress to provide special relief to recipients of coal royalties as it had previously aided the owners of timber lands. S. Rept. 781, 82d Cong., 1st Sess. (1951), 1951-2 C.B. 458, 488. It was designed to afford the owners of coal deposits capital gain treatment from the disposition of the coal. Of course, Cumberland is a recipient of coal royalties. In Union Bag-Camp Paper Corp. v. United States, 163 Ct.Cl. 525, 325 F.2d 730 (1963), the Commissioner attempted to compel the taxpayer to offset its forest management expenses against its proceeds from the sales of timber instead of allowing them as ordinary deductions. The scheme of taxation of proceeds from the sales of coal is patterned after the scheme for the taxation of the proceeds from the sale of timber. The Commissioner, in Union Bag-Camp Paper Corp. v. United States, attempted to do what he attempts to do here; i.e., convert deductions, which the taxpayer traditionally enjoyed as ordinary deductions before relief legislation, into offsets to the selling price. The Court of Claims rejected the Commissioner’s attempt. Portions of the language of the opinion in that case are applicable here because of the identical situation. The history of the tax law in this area shows with reasonable clarity that selling expenses, such as those involved here, are properly deductible from gross income and are not requred to be restricted to an offset against contract proceeds. There can be little doubt that, prior to 1944, a taxpayer engaged in the business of buying and selling of timber (such as plaintiff) was required to report the proceeds from timber sales as ordinary income and was entitled to deduct all ordinary and necessary expense attributable to such sales under section 23(a) of the 1939 Code. The tax treatment is the same today with respect to outright sales by owners holding their timber primarily for sale to customers in the ordinary course of trade or business. * * * When sections 117(k) (1) and (2) were added to the 1939 Code by the Revenue Act of 1943 (58 Stat. 46), all timber owners, including dealers, became entitled to capital gains treatment where they either cut timber for use in their business (section 117(k) (1)) or sold it to others but with a retained economic interest (section 117 (k) (2)). * * * These statutory provisions, designed by Congress “to afford relief to timber owners,” (Boeing v. United States, supra, at page 584 of 98 F.Supp. at p. 25 of 121 Ct. Cl.) contain nothing which on any normal reading would prohibit the deduction by a timber dealer from income of his ordinary and necessary expenses incurred in the growing or selling of his timber, or which would require him to offset such expenses against capital gains realized on timber sales or disposals. This Congressional omission is highly significant for two reasons. In the first place, in other situations when Congress has desired to restrict a relief provision by disallowdng deduction of related expenses, it has done so by express language. Thus, when section 117(j)(3) of the 1939 Code was added by the Revenue Act of 1951, in order to provide for the realization of capital gain on the sale of a growdng crop together with the land on which it is situated, section 24(f) was simultaneously added to prohibit the deduction of the expenses of growing such crop: In the second place, during its consideration of legislation which ultimately became the 1954 Code, the House of Representatives passed a provision which would have specifically denied a deduction for the type of expenses here involved. Sec. 272, H.R. 8300, 83d Cong., 2d Sess; see also H. Rept. No. 1337, 83d Cong., 2d Sess., pages A67-A68. However, the Senate Finance Committee eliminated this provision with respect to timber, and the Senate’s action was accepted by the Conference Committee. S. Rept. No. 1622, 83d Cong., 2d Sess., p. 229 (1954); H. Rept. No. 2543, 83d Cong., 2d Sess., p. 33 (1954). [163 Ct.Cl. at 546-548, 325 F.2d at 742-743; fn. ref. omitted.] The Court of Claims, sitting en banc, has more recently reaffirmed its decision in Union Bag-Camp in Wilmington Trust Co. v. United States, 221 Ct. Cl. _, 610 F.2d 703 (1979). Congress specifically provided that certain deductions relating to coal mining operations would not be deductible in light of section 631 treatment of the proceeds as capital gain. See sec. 272 of the Code. It did not, however, in any way direct that the royalties paid by a lessee would no longer be deductible by him when he became also a sublessor; yet, in section 631, Congress specifically provided that a sublessor would be afforded the benefits of reporting its royalty income as capital gains. The majority opinion, by telescoping into one transaction royalties paid by Cumberland before it became a sublessor with royalties paid after subleases were executed, provides a clue as to why it holds that Cumberland should not be entitled to the royalties-paid deduction it enjoyed prior to acquiring its additional status as a sublessor. That clue is unmistakably the relationship between Cumberland and Webster Coal. It may be argued that in the instant case Cumberland was nothing more than a passive investor. That may or may not be true because there are no facts in the record to explain why Cumberland, instead of Webster Coal, secured coal mining leases from the land owners. The record discloses no answers to the nagging “why” questions surrounding the relationship of Cumberland and Webster Coal and the business activities of each. The majority should not, however, let the relationship between the sublessor and sublessee in this case lead it to approve a rule not supported by law which will affect all sublessors, most of whom are not related to the sublessees. A lessee who subleases his interest fulfills a very important purpose in the development of natural resources. He is a middleman or broker who puts together blocks of leases and sells them to mining operators. He may or may not engage in the actual mining operations himself, but he can hardly be called a passive investor. He is a very important link in the.chain of operations from the owner of the natural resource to the ultimate consumer. Congress must have attached some importance to his function because it specifically provided in section 631(c) that he was the owner of an economic interest in the coal and could report his royalty income at capital gains rates. There is no evidence of congressional intent to limit or deprive him of his deductions for royalties paid as deductions against ordinary income. The sublessor was specifically referred to on “his income side” in section 631(c) but not mentioned on the deduction side in section 272. There is nothing to indicate that today Congress is unwilling to confer upon owners of coal the tax benefits it provided for in section 681(c). Those benefits are derived from the entire spectrum of coal extraction, processing, and consumption. The opposite is true, however; Congress has, in the past serveral months, demonstrated a renewed emphasis on utilizing coal for the production of energy. The attempt to deny a tax benefit between related parties does not justify upholding an invalid regulation because the Commissioner of Internal Revenue contends that the law should read that way. As stated by the Supreme Court in Calamaro v. United States, 354 U.S. 351, 357 (1957), “Neither we nor the Commissioner are authorized to rewrite the statute simply because we may feel that the scheme it creates could be improved upon.” Regulations section 1.631-3(b)(3)(ii)(a) holds that royalty payments made by a sublessor are added to the sublessor’s adjusted depletion basis. This is contrary to the entire body of tax law covering the production of natural resources and is not supported by congressional intent. The regulations under section 631(c) were not directed by Congress. They are interpretative, not legislative. As such, they are entitled to less weight than a legislative regulation. See Fishman v. Commissioner, 51 T.C. 869, 872 (1969). Because the Commissioner’s interpretation of the statute expressed in these regulations adds a requirement to the statute without authority for doing so, the regulations are invalid and should not be approved. As stated by the Supreme Court in Manhattan General Equipment Co. v. Commissioner, 297 U.S. 129 (1936): The power of an administrative officer or board to administer a federal statute and to prescribe rules and regulations to that end is not the power to make law, for no such power can be delegated by Congress, but the power to adopt regulations to carry into effect, the will of Congress as expressed by the statute. A regulation which does not do this, but operates to create a rule out of harmony with the statute, is a mere nullity. Lynch v. Tilden Produce Co., 265 U.S. 315, 320-322 (1924); Miller v. United States, 294 U.S. 435, 439, 440 (1935) and cases cited. [297 U.S. at 134.] See also Cartwright v. Commissioner, 411 U.S. 546 (1973); Joseph Weidenhoff, Inc. v. Commissioner, 32 T.C. 1222 (1959); Parker Oil Co. v. Commissioner, 58 T.C. 985 (1972); Morris v. Commissioner, 70 T.C. 959 (1978); concurring opinion of Judge Chabot in Matheson v. Commissioner, 74 T.C. 836 (1980). To the extent that section 1.631-3(b)(3)(ii)(u), Income Tax Regs., requires that royalty payments by a sublessor-lessee are to be treated as adjustments to basis rather than as deductions, the regulations are invalid. Having thus eradicated the contested regulations, I would follow the clear statutory mandate of section 631(c) and the long history of established case law and hold that petitioners are entitled to deduct the royalty payments made by Cumberland from their income under section 62(5) and either section 162(a)(3) or section 212. Section 631(c) specifically refers to sublessors of which Cumberland is one. It specifically provides for lessees of which Cumberland is one. It makes no provision for denying a sublessor-lessee the long-standing deduction for royalties paid or requiring offset against royalty income treated as captial gain. There is not the slightest indication of congressional intent to support the regulations which reduce petitioner's deduction for royalties paid. Section 631(c) was enacted to encourage production of coal, and the effect of the invalid regulation and the holding of the majority decreases deductions of sublessors to which they have long been entitled. The regulations and holding of the majority are, therefore, contrary to the intent of Congress. IV. Conclusion The dilemma faced by the majority of the Court in approving regulations which are internally inconsistent should be resolved by holding the regulations invalid. A regulation which attempts to add to a statute something which is not there can provide no sustenance to the statute. United States v. Calamaro, 354 U.S. 351, 359 (1957); Koshland v. Helvering, 298 U.S. 441, 446-447 (1936). As the Supreme Court stated in United States v. Calamaro, supra, in considering the validity of examples in Treasury regulations, “Apart from this, the force of this Treasury Regulation as an aid to the interpretation of the statute is impaired by its own internal inconsistency.” (Fn. ref. omitted.) See also Lafayette Distributors, Inc. v. United States, 397 F. Supp. 719 (W.D. La. 1975). The situation here is not one where the internal inconsistency of the regulations can be resolved one way or the other because one interpretation is supported by the law or administrative interpretation. Nico v. Commissioner, 67 T.C. 647 (1977). Here, neither interpretation of section 631(c) of the Code is valid. The body of section 1.631-3(b)(ii)(a), Income Tax Regs., and the example in section 1.631-3(b)(ii)(6), Income Tax Regs., are not only inconsistent, both are invalid. Cumberland’s deductions for royalties paid should be allowed as an ordinary deduction as mandated by section 631 of the Code. Irwin, Wiles, and Parker, JJ., agree with this dissenting opinion.   Sec. 631(c) provides: (c) Disposal of Coal or Domestic Iron Ore With a Retained Economic Interest. — In the case of the disposal of coal (including lignite), or iron ore mined in the United States, held for more than 6 months before such disposal, by the owner thereof under any form of contract by virtue of which such owner retains an economic interest in such coal or iron ore, the difference between the amount realized from the disposal of such coal or iron ore and the adjusted depletion basis thereof plus the deductions disallowed for the taxable year under section 272 shall be considered as though it were a gain or loss, as the case may be, on the sale of such coal or iron ore. Such owner shall not be entitled to the allowance for percentage depletion provided in section 613 with respect to such coal or iron ore. This subsection shall not apply to income realized by any owner as a co-adventurer, partner, or principal in the mining of such coal or iron ore, and the word “owner” means any person who owns an economic interest in coal or iron ore in place, including a sublessor. The date of disposal of such coal or iron ore shall be deemed to be the date such coal or iron ore is mined. In determining the gross income, the adjusted gross income, or the taxable income of the lessee, the deductions allowable with respect to rents and royalties shall be determined without regard to the provisions of this subsection. This subsection shall have no appliction, for purposes of applying subchapter 6, relating to corporations used to avoid income tax on shareholders (including the determinations of the amount of the deductions under section 535(b)(6) or section 545(b)(5)). This subsection shall not apply to any disposal of iron ore— (1) to a person whose relationship to the person disposing of such iron ore would result in the disallowance of losses under section 267 or 707(b), or (2) to a person owned or controlled directly or indirectly by the same interests which own or control the person disposing of such iron ore.    “Earned royalties” is a term used in the Cuinberland-Webster Coal subleases. It is a term not used in the tax law and for good reason. Royalties are not “earned” but are, instead, received by reason of disposition of the mineral.