Court Opinion

ID: 8596289
Source: CourtListenerOpinion
Date Created: 2022-11-23 16:03:31.792382+00
Date Added: 2024-06-11T16:54:57.460944
License: Public Domain

Miller, Judge,
dissenting:
I am not persuaded that plaintiff has carried its burden of proving that, during its fiscal year ended March 31, 1974, and for purposes of I.R.C. § 611, it owned an "economic interest” (as distinguished from an "economic advantage”) in the No. 9 coal in place under the lease from AMAX to James R. Thornberry, as limited under the *211March 1, 1973, assignment from James R. Thornberry to plaintiff.
Pursuant to I.R.C. § 611(a), Treasury promulgated Regulation § 1.611 — 1(b)(1), defining "economic interest” thus:
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 he must look for a return of his capital. But a person who has no capital investment in the mineral deposit. . . does not possess an economic interest merely because through a contractual relation he possesses a mere economic or pecuniary advantage derived from production. For example, an agreement between the owner of an economic interest and another entitling the latter . . . to compensation for extraction . . . does not convey a depletable economic interest.
As this court said in Food Machinery and Chemical Corp. v. United States, 172 Ct. Cl. 313, 322-23, 348 F.2d 921, 926 (1965):
This economic interest . . . test developed by the Court in Palmer [Palmer v. Bender, 287 U.S. 551 (1933)] has been the rule used in all subsequent depletion cases . . . [and] boils down to two tests for economic interest: (1) A capital investment in the mineral in place, and (2) a return on the investment which is realized solely from the extraction of the mineral. [Footnote omitted.]
The requirement of "a capital investment in the mineral in place” does not demand legal title to the mineral in place.1 Rather, as developed by judicial decisions, the requirement may be satisfied by the legal fiction of a "constructive investment” in the mineral in place. In Bakertown Coal Co. v. United States, supra note 1 at 851, 485 F.2d at 638, this court, discussing G.C.M. 26290, 1950-1 C.B. 42, alluded to—
*212the constructive equivalent of the fee or leasehold rights of control over extraction and disposition of the underlying mineral historically regarded as the embodiment of the capital investment prerequisite to a depletable interest in the deposit.
See Rev. Rul. 56-542, 1956-2 C.B. 327, 328. Thus, the allowance for a percentage depletion deduction does not necessarily depend on direct investment of money in the mineral deposit. Commissioner v. Southwest Exploration Co., 350 U.S. 308, 312 (1956).
However, constructive investment in the mineral in place does not result from the purchase of movable equipment used to extract the mineral (Parsons v. Smith, 359 U.S. 215 (1959), aff’g 255 F.2d 595 (3d Cir. 1958));2 nor from construction of access roads (Denise Coal Co. v. Commissioner, 271 F.2d 930 (3d Cir. 1959)); nor from removal of overburden to enable the coal to be stripped (see Parsons v. Smith, supra at 217); nor from construction of a tipple, a power line, a railroad siding, and engineering services (Paragon Jewel Coal Co. v. Commissioner, 380 U.S. 624 (1965).
The trial judge found that plaintiff "made substantial expenditures in connection with mining and selling the coal (mining engineering expenses, equipment costs, expenses of construction of a haul road and stockpile area, the costs of relocating a cemetery entrance road and a county road, and the costs of a strip mining permit and a reclamation bond). However, unlike the permanently-installed equipment in Food Machinery and Chemical Corp., supra, plaintiffs equipment was movable and could, therefore, later be used for mining operations elsewhere; moreover, plaintiff claimed deductions for depreciation on the equipment — a means of restoring its capital investment. The trial judge found that the engineering expenses, expenses of construction of the haul road and stockpile area, and the costs of relocating the cemetery entrance *213road were deducted as current business expenses, as were the costs of the mining and reclamation bond; that the cost of relocating the county road was capitalized and "depreciated [sic, amortized?] beginning in plaintiffs fiscal year ended March 31, 1974.” At oral hearing, plaintiffs counsel suggested that the cost of removing the overburden constituted the requisite "capital investment in the mineral in place,” but admitted that this cost had been deducted as an expense. He also suggested that the royalties paid by plaintiff to AMAX represented a capital investment, but it is noted that these were payable only after the coal was "mined, removed, and sold” to Talbert, so they could hardly be regarded as an "investment in the mineral in place.”
During the taxable year in question,3 the salient features of plaintiffs contractual relationship with respect to the No. 9 coal in place were as follows:
(1) It was provided that AMAX "does hereby lease, sublease and let unto Lessee [James R. Thornberry] all of the Kentucky #9 Vein or Seam of coal” underlying described real estate. The assignment from James R. Thornberry to plaintiff limited plaintiff to extracting 800,000 tons of said coal.
(2) Royalty payments were to be made to AMAX in the amount of 75ff per ton "for each and every ton of 2,000 pounds of Kentucky #9 Coal mined, removed and sold. from the leased premises.” (Emphasis supplied.)
(3) The agreement was not terminable by the lessor at will or on short notice,4 except (as expressly provided) in the event of plaintiffs failure "for any reason” to sell all the No. 9 coal to Talbert or in the event of plaintiffs failure to manage its labor force in a manner which would not interfere with AMAX’s own mining operation, and except (as implied) in the event of plaintiffs failure to perform according to other terms of the lease from AMAX to James *214R. Thornberry, including a "Covenant for Diligent Operation.”5
(4) The term of the lease from AMAX to James R. Thornberry ran from February 14, 1973, through February 28, 1975. The assignment from James R. Thornberry to plaintiff limited plaintiff’s term to run from March 1, 1973, "until such time as the Assignee [plaintiff] has removed 800,000 tons of coal from the property.”6
(5) Unlike the assignor, James R. Thornberry, plaintiff did not have the right to mine unlimited quantities of the No. 9 coal.7 During the taxable year, plaintiff mined some 442,000 tons of coal, all of which it sold to Talbert. Although Hopper, the president of AMAX, testified that plaintiff was free to sell to anyone any coal that was surplus to Talbert’s needs, this was not provided for in the lease. Also, it should be noted that the 800,000 tons limit on plaintiffs right to mine coal was equal to Talbert’s requirements for a two-year period.
(6) Plaintiff was not free to sell to whomever and at whatever price it chose,8 but had to rely on what was essentially a fixed price contract (with a production cost escalation provision) negotiated with Talbert.9 A mutually acceptable contract between Talbert and the Thornberrys *215to meet Talbert’s needs for 400,000 tons of No. 9 coal per year for two years was a condition precedent to AMAX’s executing the lease to James R. Thornberry.
(7) Because of the Covenant for Diligent Operation, plaintiff was not free to produce as it chose. See Helvering v. Bankline Oil Co., 303 U.S. 362, 368 (1938).
The trial judge has clearly erred, as a matter of law, in interpreting the lease and assignment to have "conferred upon plaintiff the rights to mine coal and to sell that coal, at whatever price it could obtain therefor, to an independent, unrelated third party (albeit a valued customer of AMAX), and not to AMAX itself.” It is true that the lease from AMAX to James R. Thornberry, par. (6), required that all Kentucky No. 9 coal be sold to Talbert, and this obligation was transferred to plaintiff by the assignment from James R. Thornberry. However, the contract covering the sale of coal by plaintiff to Talbert at the price they had negotiated was entered into before, and as a condition precedent to,10 AMAX’s execution of the lease to James R. Thornberry. What was, in substance, a fixed price contract (subject to adjustments for plaintiffs increased costs, but not for market fluctuations) was locked up first, and the subsequent lease from AMAX and assignment from James R. Thornberry did not confer upon plaintiff any right to change either the price or the purchaser under that contract. As a matter of economic reality, the fact that the lease and assignment obligated plaintiff to sell the coal to AMAX’s designee (Talbert), rather than to AMAX itself, is without significance. In *216either event, plaintiff was not free to sell "to whomever and at whatever prices” it chose, as was the situation in Bakertown Coal Co. v. United States, supra.
The trial judge has found that Hopper testified as "a credible and persuasive witness” that "plaintiff owned the coal it mined and was free to sell any of that coal surplus to Mr. Talbert’s needs to anyone.” However, any freedom to sell coal surplus to Talbert’s needs which, as pointed out earlier, was not provided for in the lease, was purely cosmetic, since Talbert would have been expected to purchase all of the coal mined by plaintiff during the taxable year in question. Further, it should be emphasized that ownership of "the coal it mined” (not to exceed 800,000 tons under the assignment to plaintiff) would not have been ownership of the coal in place. Whether lease of the vein or seam of coal to James R. Thornberry conveyed ownership of the coal in place is not before us.
The trial judge has also found that for federal income tax purposes, AMAX treated the royalties received from plaintiff as long-term capital gain, and he has concluded that this demonstrated "its intent to, and belief it had, conveyed [sic] an economic interest in the coal in place to plaintiff.” However, AMAX’s unilateral intent and belief are clearly not controlling; what the parties did is controlling.
Finally, the trial judge clearly erred in concluding, as a matter of law, that, for purposes of Treas. Regs. § 1.611 — 1(b)(1), plaintiff "could and did look solely to the income thus derived [from the extraction of coal] for a return of its capital.” If, in fact, plaintiff had been free to sell the mined coal at a price reflecting the market, as was the situation in Bakertown Coal Co. v. United States, supra, such a conclusion might well be correct. However, in applying the language just quoted, which was taken largely from Treasury Regulation § 1.611 — 1(b)(1), the Supreme Court in Paragon Jewel Coal Co. v. Commissioner, supra at 635, stated:
As we said in Palmer v. Bender, 287 U.S. 551, 557 (1933), the deduction [for depletion] is allowed only to one who "has acquired, by investment, any interest in the oil in place, and secures, by any form of legal *217relationship, income derived from the extraction of the oil, to which he must look for a return of his capital.” (Emphasis supplied.) Here, Paragon was bound to pay the posted fee regardless of the condition of the market at the time of the particular delivery and thus the contract miners did not look to the sale of the coal for a return of their investment, but looked solely to Paragon to abide by its covenant.
So too, here, regardless of the condition of the market, Talbert was bound to pay plaintiff the agreed-upon price, so that plaintiff did not look to the sale of the coal, but solely to Talbert to abide by his agreement. See Parsons v. Smith, supra at 225, citing Helvering v. O’Donnell, 303 U.S. 370, 372 (1938);11 Usibelli v. Commissioner, 229 F.2d 539, 543-44 (9th Cir. 1955).
Under either test set forth in Food Machinery and Chemical Corp. v. United States, supra, plaintiff has failed to show that it owned an economic interest in the No. 9 coal in place.12
Accordingly, plaintiffs petition should be dismissed.
CONCLUSION OF LAW
Upon the trial judge’s findings and foregoing opinion, which are adopted by the court, the court concludes as a matter of law that plaintiff is entitled to recover and judgment is entered to that effect. Absent a stipulation of the parties as to the amount of recovery due plaintiff, that *218amount is to be determined in further proceedings pursuant to Rule 131(c).

 "The technical title to the oil in place is not important.” Kirby Petroleum Co. v. Commissioner, 326 U.S. 599, 603 (1946). As pointed out in Bakertown Coal Co. v. United States, 202 Ct. Cl. 842, 849, 485 F.2d 633, 637 (1973), in 1950 Treasury first compromised the requirement of a legal interest in the mineral in place. G.C.M. 26290, 1950-1 C.B. 42.

 In Food Machinery & Chemical Corp. v. United States, supra, the taxpayer had invested $20 million in four permanently-installed electric furnaces and related plant equipment used to reduce the phosphate shale that was mined. The requisite "investment in the mineral in place” was held to be present, because the taxpayer’s economic interest was so strong. C.B.N. Corp. v. United States, 176 Ct. Cl. 861, 868 n.3, 364 F.2d 393, 398 n.3 (1966).

 Some changes occurred in the relationship of plaintiff with AMAX and with Talbert following the close of the taxable year, but these cannot be regarded as having had any retroactive effect as far as the taxable year in question is concerned.

 However, terminability was clearly not regarded as controlling by this court in Bakertown Coal Co. v. United States, supra at 853-56, 485 F.2d at 639-40, although Judge Nichols in his dissenting opinion thought otherwise. In Parsons v. Smith, supra at 224, the Court, in holding that strip mining contractors did not own an economic interest, emphasized that the contracts "were completely terminable without cause on short notice.”

 This provided as follows:
Lessee, with all reasonable dispatch and as soon as practicable hereafter, shall enter upon the said leased premises and begin and continue mining operations thereon, it being the purpose and spirit of this Lease to secure the prompt development and continuous operation of mining and removing said coal and to secure as full, complete and speedy operation thereof as can be done practicably and economically by Lessee.

 Plaintiffs term under the assignment actually expired October 10, 1974, by which date plaintiff had mined 800,000 tons of No. 9 coal. Thereupon, the lease was reassigned to James M. Thornberry (sole). The trial judge found that in November 1974 plaintiff purchased surface rights in certain reserves of No. 9 coal, but this finding has no relevance to the taxable year in question.

 The right to mine unlimited quantities of coal from designated areas on which royalties were to be paid to the lessor was one of the three "relevant features” of the agreements underscored by this court in Bakertown Coal Co. v. United States, supra at 844, 485 F.2d at 634.

 The right of lessees "to extract and dispose of the coal underlying the leased premises to whomever and at whatever prices they chose” was clearly a decisive factor in Bakertown Coal Co. v. United States,supra at 857-58, 485 F.2d at 642. See the dissenting opinion of then Chief Judge Drennan in Charles P. Mullins, 48 T.C. 571, 583 (1967), on which this court relied in Bakertown.

 During the taxable year in question, there was no agreement between plaintiff and Talbert for any increases in the price of coal sold to Talbert to reflect market fluctuations. Talbert paid $5.90 per ton from April 1 to May 15, 1973. To reflect plaintiffs cost increases, Talbert paid $5.95 per ton from May 16 to August 15, 1973; $6.00 per ton from August 16 to November 15, 1973; and $6.27 per ton from November 16, 1973, to March 31, 1974.

 According to the trial judge’s finding No. 18, "Mr. Hopper [AMAX’s president] also told Mr. Thornberry that if he could 'work out something’ with Mr. Talbert, AMAX would lease the no. 9 coal to Mr. Thornberry.” According to the trial judge’s finding No. 19(c), "Prior to February 14, 1973 [date of the lease from AMAX to James R. Thornberry]. . . Mr. [James M.] Thornberry and Mr. Talbert then entered into an oral agreement for the sale by plaintiff to Mr. Talbert of approximately 400,000 tons of no. 9 coal per year for two years, at a base price of $5.75 per ton. That oral agreement included a 'cost escalation’ provision pursuant to which Mr. Talbert agreed to compensate plaintiff for any documented increased production costs, with such cost increases to be determined on a semi-annual basis. Neither Mr. Thornberry nor Mr. Talbert discussed possible downward cost escalation, nor were possible price increases due to changes in market conditions either anticipated or discussed. The Thornberrys thereafter advised Mr. Hopper that they had reached an agreement with Mr. Talbert, and that they would like to lease AMAX’s no. 9 coal reserve.” [Footnote omitted.]

 The Third Circuit in Parsons v. Smith, supra at 597, after noting that there was a set price, not geared to the market, said: "And since that price did not fluctuate with the market, there is nothing about the scheme of payment to indicate any interest of the contractor in the mineral.”

 During the taxable year in question, plaintiff operated essentially as a contract coal miner, obligated to diligently mine and sell coal to Talbert at a fixed price and to pay royalties to AMAX. In its opinion in Paragon Jewel Coal Co. v. Commissioner, supra at 637, the Court provided a further basis for holding that plaintiff here was not the "owner” of an economic interest in the No. 9 coal in place:
In contrast to the language in § 631 (c), it is noted that in treating with timber in § 631 (b) an "owner” is allowed capital gains instead of depletion. In this instance "owner” is defined to be "any person who owns an interest in such timber, including a sublessor and a holder of a contract to cut timber.” (Emphasis supplied.) This last phrase as to contractors is not included in § 631 (c) thus indicating that as to coal, "owner” does not include contract coal miners. Clearly the Congress knew what language to use when it wished to give a contractor a tax allowance. It gave holders of contracts to cut timber capital gains treatment in § 631 (b) but did not so provide for contract coal miners in § 631(c).