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allowance any part of development costs not borne by the lessor nor any part of the discovery value. (Art. 202.)

The last sentence in the foregoing regulation is not clear. As the law provides that the fair market value within thirty days after discovery fixes the capital amount which a discoverer is entitled to recover through depletion charges, it is not clear why he should be deprived of his right because he leases his property to another.

Stockholder may not claim depletion. It will be noted that a stockholder in a mining or oil or gas corporation is not entitled to any allowance for depletion, as the depletion claimed by and allowed to the corporation exhausts the allowable deduction.

REGULATION. .... Operating owners, lessors and lessees are entitled to deduct an allowance for depletion, but a stockholder in a mining or oil or gas corporation is not. .... (Art. 201.)

Depletion allowances to lessees.—The 1918 law fully recognizes that leases are property and may be revalued as of March 1, 1913, such value to be returned to the lessee through depletion charges without any tax being levied. This point is settled by the specific provision that “the taxpayer's interest” in “the fair market value of the property" acquired prior to March 1, 1913, is the basis of the deductions permitted. In the opinion of the author lessees have always had the same rights and privileges, in regard to depletion, as were accorded to owners under the 1913 and 1916 laws.

REGULATION. In the case of a lessee the capital remaining in any year recoverable through depletion allowances is the sum of (a) the cost of the leasehold, 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

"For former procedure and criticism of regulations and rulings, see Income Tax Procedure, 1918, pages 409-410, and Income Tax Procedure, 1919, pages 611-613.

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. Any annual or periodical rents or royalties supplementing the bonus or other amount paid for the lease may be charged to current operating expenses or, until the property reaches the operating stage, to capital account, and in the latter event will form part of the capital returnable through deductions for depletion. (Art. 203.)

In a very recent decision the court held:

Decision. The question of law presented for decision is whether or not the plaintiff is entitled to deduct a reasonable allowance for depletion of iron ore from the gross amount of its receipts from all sources in order to determine the net income subject to tax. The answer to this question turns on the true meaning of section 12 of the Revenue Act of September 18, 1916. The government's contention is that the deduction authorized by the second subdivision of this section is allowable only to an operating owner of an ore mine and not to an operating lessee under a lease of the character stated. ....

I have carefully examined all of the cases decided under the corporation tax act of 1909 and under the several income tax acts and have also carefully studied the several provisions of these several acts so far as they relate to this question. My conclusion is that the operating lessee is entitled to the deduction as claimed.

APPORTIONMENT OF DEDUCTIONS BETWEEN LESSOR AND LESSEE.-

REGULATION. As the value of property comprehends the interests of both lessor and lessee, no computation, for the purpose of depletion allowances, of the value of these interests separately as of any date which combined exceeds the value of the property in fee simple will be permitted. The same principle applies to holders of fractional interests. If the aggregate deduction claimed is deemed excessive, the Commissioner may request the owner or lessee to show that the valuation claimed does not exceed the fair market value of the property at a specified date determined in the manner explained in article 206. The lessor and lessee shall, with the approval of the Commissioner, equitably apportion the allowance in the light of the peculiar conditions in each case and on the basis of their respective interests therein. To the return of every taxpayer claiming an allowance for depletion in respect of (a) property in which he owns a fractional interest only or (b) a leasehold or (c) property subject to a lease, there shall be attached a statement set

Mohawk Mining Co. v. Weiss, Collector, U. S. Dist. Court, Northern District of Ohio, Eastern Division (November 3, 1919).

ting forth the name and address and the precise nature of the holdings of each person interested in the property. (Art. 204.)

Development costs.—Development costs, as heretofore, may be added to capital investment and charged off thereafter as a part of depreciation or depletion, or if the items can be held to be proper operating costs they may be omitted from the annual deduction and charged direct to maintenance.

To the cost of the fee or the lease for the purposes of depletion there may be added in the case of both owner and lessee, “the cost of subsequent improvements and development not charged to current operating expenses."8

Depletion basis for discoverers.-A new clause is found in the 1918 law which, in effect, permits the original discoverer of a mine or oil well to set up the market value of a new discovery as a basis for depletion charges, when the discovery is after March 1, 1913, and irrespective of cost, provided the cost is materially disproportionate to the value.

It has been assumed by some that the statement in the law, to the effect that as to all discoveries on and after March 1, 1913, the discoverer shall get back the market value through depletion, justifies amended returns for prior years so that the depletion charge shall commence in the year of discovery. The author does not so interpret the law. There is no doubt

*[Former Procedure]

REGULATION. “The incidental expenses of drilling wells, that is, such expenses as are paid for wages, fuel, repairs, etc., which do not necessarily enter into and form a part of the capital invested or property account, may, at the option of the individual or corporation owning and operating the property, be charged to property account subject to depreciation, or be deducted from gross income as an operating expense. If, in exercising the option, the operating individual or company charges the expense of drilling wells to property account, the same may be taken into account in determining a reasonable allowance for depreciation during each year, until the property account thus augmented has been extinguished through annual depreciation deductions, after which no further deduction on this account will be permitted. The cost of drilling dry or non-productive wells may be deducted from gross income as a loss." (T. D. 2447, February 8, 1917.)

Section 214 (a-10). For mines, see page 780. For oil and gas wells, see page 786.

about the right of a discoverer to charge depletion on the basis of value instead of on cost, but it was hardly the intention of Congress to permit the increased depletion charge before January 1, 1918.

There is no doubt, however, of the right to revalue at any time after March 1, 1913. If a discoverer paid $1,000 for unproven acreage in 1915, and discovered oil thereon worth $1,000,000, he would only be entitled to charge depletion up to January 1, 1918, on the $1,000. Commencing January 1, 1918, he may charge depletion on the $1,000,000 revaluation.

Advance royalties–Depletion basis.-Leases of mineral lands frequently provide that minimum royalties must be paid in advance, irrespective of mining operations. The question arises as to whether a lessor should be entitled to claim an allowance for depletion as directly chargeable against the royalty receipts, or whether he should be entitled to the deduction only if and when it can be shown that the number of units for which a deduction is claimed have been removed from the ground. If the lessee fails to remove the stipulated quantity within the period mentioned in the lease or for other causes, the lessor may repossess the property. In such case he will find himself in the embarrassing position of having claimed a deduction covering the removal of a given number of units, whereas his property is intact or a less quantity has been extracted than has been claimed. So much for the government's side.

If the lessor receives advance royalty payments during one period, and cannot claim an allowance for depletion until some subsequent period when proof can be offered to support the claim, it may be that the tax on the royalties reported as gross income will be at a higher rate than when the deduction is permitted. Or it may be that in the subsequent period the receipts will be small and the allowable deductions larger than the gross receipts. The matter is important if graduated tax rates are involved. So much for the taxpayer's side.

In the regulations the Treasury takes a liberal attitude. Owners in receipt of royalties must report royalties as taxable income but are permitted to deduct depletion even though there has been no extraction during the taxable year. It is, however, provided that if the deductions are found to be unwarranted because the minerals were not really taken out, upon repossession the amount theretofore claimed for depletion must be returned as income for the year when the property is repossessed. The actual effect of this might be the imposition of an extremely large tax for one year. It would be more equitable if amended returns were permitted.10

Dividends declared out of depletion reserves.-Certain mining companies have paid dividends which have been declared to be out of depletion reserves instead of earned surplus. For a discussion of this practice, see page 468.

REGULATION. . . . . If dividends are paid out of a depletion or depreciation reserve, the stockholders must be expressly notified that the dividend is a return of capital and not an ordinary dividend out of profits. .... (Art. 216.)

Depletion basis when resources are unworkable within reasonable period.—The usual rule is that depletion charges represent the book value of the quantity mined at the per unit value, established by dividing the cost or value at March 1, 1913, by the entire estimated contents of the mine. This rule works well in all cases when the life of a mine is short. In practice it works well also when the life of a mine is not short because it is not customary to include in the aggregate contents of a mine the ore or coal which cannot be mined within a reasonable time. Otherwise the owner of a mine would receive credit for an insufficient depletion charge during the early years of operation.

The reason is that, in effect, nothing is paid for the ore or coal in the ground which cannot be reached by ordinary

10For full discussion of this subject, see page 390.

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