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desirable to transfer therefrom, once a year, to the regular surplus account an amount representing the difference between the aggregate depletion actually charged and the amount which would have been charged on the basis used before revaluation. The chief reason for making such transfer is that the item “invested capital” as defined by the excess profits tax law does not recognize appreciation arising out of revaluations unless a sale takes place, but cash realizations of any part of the assets reappraised are recognized as additions to invested capital, commencing with the dates of realization.

For method of separating ledger accounts so that surplus accrued before and after March 1, 1913, will be properly divided, see page 340.

REGULATIONS. A reasonable deduction from gross income for the depletion of natural deposits and for the. depreciation of improvements is permitted, based (a) upon cost, if acquired after February 28, 1913, or (b) upon the fair market value as of March I, 1913, if acquired prior thereto, or (c) upon the fair market value within thirty days after the date of discovery in the case of mines, oil and gas wells discovered by the taxpayer after February 28, 1913, where the fair market value is materially disproportionate to the cost. The essence of this provision is that the owner of such property, whether it be a leasehold or freehold, shall secure through an aggregate of annual depletion and depreciation deductions a return of the amount of capital invested by him in the property, or in lieu thereof an amount equal to the fair market value as of March 1, 1913, of the properties owned prior to that date, or an amount equal to the fair market value within thirty days after the date of discovery of mines, oil or gas wells discovered by the taxpayer on or after March 1, 1913, and not acquired as the result of purchase of a proven tract or lease, where the fair market value of the property is materially disproportionate to the cost; plus in any case the subsequent cost of plant and equipment (less salvage value) and underground and overground development, which is not chargeable to current operating expense, but not including land values for purposes other than the extraction of minerals. .... (Art. 201.)

In any case in which a depletion or depreciation deduction is computed on the basis of the cost or price at which any mine, mineral deposit, mineral right or leasehold was acquired, the owner or lessee will be required upon request of the Commissioner to show that the cost or price at which the property was bought was fixed for the purpose of a bona fide purchase and sale, by which the

property passed to an owner in fact as well as in form different from the vendor. No fictitious or inflated cost or price will be permitted to form the basis of any calculation of a depletion or depreciation deduction, and in determining whether or not the price or cost at which any purchase or sale was made represented the actual market value of the property sold, due weight will be given to the relationship or connection existing between the person selling the property and the buyer thereof. (Art. 205.)

Where the fair market value of the property at a specified date in lieu of the cost thereof is the basis for depletion and depreciation deductions, such value must be determined, subject to approval or revision by the Commissioner, by the owner of the property in the light of the conditions and circumstances known at that date, regardless of later discoveries or developments in the property or in methods of mining or extraction. The value sought should be that established assuming a transfer between a willing seller and a willing buyer as of that particular date. No rule or method of determining the fair market value of mineral property is prescribed, but the Commissioner will lend due weight and consideration to any and all factors and evidence having a bearing on the market value, such as cost, actual sales and transfers of similar properties, market value of stock or shares, royalties and rentals, value fixed by the owner for purposes of the capital stock tax,y valuation for local or State taxation, partnership accountings, records of litigation in which the value of the property was in question, the amount at which the property may have been inventor ed in probate court, disinterested appraisals by approved methods, and other factors. (Art. 206.)

Evidence required to support depletion charges.—The law permits a reasonable allowance for depletion and no more. It is proper and necessary that taxpayers should comply with all reasonable Treasury requirements and furnish detailed evidence bearing on the propriety of the deductions claimed.

2“We believe we have demonstrated by the opinions of leading courts and by general reasoning, and by illustration taken from the history of the very companies involved, that to attempt to establish value of the property of the company by referring to the market value of its securities is so unreliable as to forbid its employment if a way is offered or can be devised of arriving at actual values. It is not in the discretion of the Internal Revenue Department to adopt the one or the other at its pleasure.” (Extract from memorandum submitted to the Commissioner of Internal Revenue by the Ray Consolidated Copper Company.)

The connection of the capital stock tax law with fair values of minerals on March 1, 1913, is remote, to say the least, in view of the fact that the first report under the capital stock tax law was not due until 1917,

In addition to the regulations reproduced in full in this book the Treasury has prepared a comprehensive "schedule of depletion" consisting of a booklet of more than fifty pages. The information required includes maps of the property; full particulars of contents and production at March 1, 1913, and subsequently; kinds of ore or mineral produced; manner of acquisition and when cash was not paid for property cash value of securities issued; details of appraisals, if any; details of sales of similar properties; estimates of deposits made by engineers or others; assessments for local taxation; sales of securities on exchanges or at private sale; partnership or estate accountings, if any, about March 1, 1913; various other details are required and all of them are pertinent and proper.

It should be noted, however, that the so-called market value of the securities of a corporation frequently is not a true indication of the fair market value of any particular asset. The courts have so decided many times.

Revaluation after March 1, 1913, not permitted except in case of discoveries.

REGULATION. The cost of the property or its fair market value at a specified date, as the case may be, plus subsequent charges to capital account not deductible as current expense, will be the basis for determining the depletion and depreciation deductions for each year during the continuance of the ownership under which the fair market value or cost was fixed, and during such ownership there can be no revaluation for the purpose of this deduction. This rule will not forbid the redistribution of the capital account over the estimated number of units remaining in the property in accordance with either of the next two articles.4 (Art. 207.)

Revision of depletion bases.- .

REGULATION. When the cost or value as of March 1, 1913, or within thirty days after the date of discovery of the property shall have been determined, and the number of mineral units in the property as of the date of acquisition or valuation shall have been estimated, the division of the former amount by the latter figure will give the unit value for purposes of depletion, and the depletion

*For mines, see age 780. For oil and gas wells, see page 786.

allowance for the taxable year may be computed by multiplying such unit value by the number of units of mineral extracted during the year. If, however, proper additions are made to the capital account represented by the original cost or value of the property, or unforeseen circumstances necessitate a revised estimate of the number of mineral units in the ground, a new unit value for purposes of depletion may be found by dividing the capital account at the end of the year, less deductions for depletion to the beginning of the taxable year which have or should have been taken, by the number of units in the ground at the beginning of the taxable year. This number, unless a revision of the original estimate has been necessary, will equal the number of units in the ground at the date of. original acquisition or valuation less the number extracted prior to the taxable year. If, however, a recalculation is needed, the number of units at the beginning of the year will be the sum of the gross production of the year and the estimated mineral reserves in the property at the end of the year. (Art. 210.)

Depletion may be deductible even if not on books.-As with depreciation, depletion charges should appear on the books and the book figures should conform exactly with those : given in the returns. If it has not been the practice to record depletion, no time should be lost in making the proper book entries. However, the courts thus far have taken the position that the taxpayer cannot be deprived of the right to deduct depletion because of a failure properly to record the charges.

DECISION. The United States District Court has held that a coal company was entitled to a deduction of 15 cents for each ton mined as an allowance for depletion. The fact that this amount was incorrectly carried on the books of the company in surplus account instead of as depletion reserve did not justify the Government in disallowing the deduction. (Forty Fort Coal Co. v. Kirkendall, Collector, 233 Fed. 704.)

Under the 1918 law the Commissioner is authorized to require taxpayers to adhere to good accounting practice. The courts may and should interpret this to mean that if depletion is not set up on the books the claim will not be allowed for income tax purposes. Moreover, the deduction claimed in the return should agree exactly with the books.

Depletion allowances to lessors.-The 1918 laws provides that "in the case of leases the deductions allowed by this paragraph shall be equitably apportioned between the lessor and lessee.” The depletion allowance to lessors is fully discussed in the text following.

If the lessor is entitled to a sliding scale of royalties or, as in the case of oil wells, he receives in addition to a bonus a specific part of the whole product (one-eighth of the product being a widely used figure), he will follow the same procedure as an owner who is also an operator. Revaluations as of March 1, 1913, may be placed on the books.

When leases are for a fixed royalty per unit, appreciation in value prior to March 1, 1913, usually accrues solely to the lessee. Therefore, the provision in the law that the depletion charge shall be equitably apportioned as related to March 1, 1913, values usually applies only to cases in which the lessor participates in the realization of the appreciation.

In all cases the lessor merely gets back through depletion his capital investment or value at March 1, 1913, and the lessee through depletion charges gets back his investment or value at March 1, 1913; and in no case must the aggregate depletion charges to lessor and lessee exceed the aggregate capital investment.

case of an operativerable throughof its fair sor the capiza the sum of (a) 1913, or its faie, plus (b) the costent

Method of determining depletion.

REGULATION. In the case of an operating owner in fee or a lessor the capital remaining in any year recoverable through depletion allowances is the sum of (a) the cost of the property, or its fair market value as of March 1, 1913, or its fair market value within thirty days after discovery, as the case may be, plus (b) the cost of subsequent improvements and development not charged to current operating expenses, but minus (c) deductions for depletion which has or should have been taken to date and (d) the portion of the capital account, if any, as to which depreciation has been and is being deducted instead of depletion. The value of the surface of the land should be taken into consideration. In no case, however, may a lessor include in his capital recoverable through such an

nifsequent improvembut minus (c) de and (d) the apo been and is

'Sections 214 (a-10) and 234 (a-9).

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