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.

118

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, aiter 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.1o

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

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

mining methods within a reasonable number of years. If the regulations were literally followed it would result inequitably and would not return the capital of the owner or lessor as the law provides.

A copper or anthracite mine might have an estimated life of 100 years, but no sane purchaser would tie up any of his capital for 100 years. The fair market value of mining property is based on the possible (or probable) extraction of the mineral content during, say, 20 or 30 years or more, depending on the circumstances of each case; and this aggregate quantity if determined by careful estimates is the proper amount by which the cost or value of the mine should be divided to ascertain the per unit cost for depletion purposes.

If all future and prospective extraction were to be considered as an element of the calculation it would be necessary to include as a factor the question of interest on capital. In other words, if the entire possible contents of a mine were to be used as a divisor it would be necessary to compute the depletion charge on a sliding scale. It might be that the total contents of a mine would be estimated at 1,000,000 tons. If the cost or value at March 1, 1913, were $100,000, the theoretical depletion charge would be 10 cents a ton, but if part of the contents could not be extracted for 50 years it would be evident that the purchaser did not pay 10 cents a ton for that part of the contents which would not be mined for 40 or 50 years. The capital invested was only intended to cover the extraction during a period which warranted an investment. If the capital were spread over a period longer than twenty or thirty years, the owner would expect in some way to be recompensed for the use of long time capital investment through the equivalent of an interest return.

The simplest method of handling a case of this sort would be to segregate any part of the estimated contents not removable within a profitable period, and, if it represented any capital investment, such part of the asset should be carried to a separate account designated as investment not subject to

depletion. If that part of the property were opened subsequently, depletion charges would commence as if it were a new property. The investment in the mine which the owner knows will be operated and expects to have repaid through depletion charges would then appear at cost or value March 1, 1913; and the resulting book value of the investment divided by the quantity removable within a reasonable time would give the unit value for depletion purposes.

It may be urged that at the end of each year a certain quantity of mineral has been extracted, but its place is taken, in effect, by an equal quantity which at the end of the year has in point of time been moved forward from just outside the period to just inside the period. So year by year the depletion is made good by other mineral covered by the original purchase. If this line of reasoning were sound no depletion. should be allowed. But the reasoning is not sound.

In most cases in which the extent of the deposits is known at the time of purchase there is a definite distinction drawn as to the value after a certain number of years, and there is the expectation that the cost of mining after a certain period will be too great to meet the competition of more favorably situated deposits. In such cases the postponement of the depletion charge would be unfair. If the later costs of mining, due to the depth of the deposit, for instance, were far greater than the earlier costs, it is conceivable that there would be no margin to cover high enough depletion in the aggregate to return the entire capital invested.

The court decisions establish the principle that the capital invested in specific property represents the amount which must be returned to the taxpayer free from the tax. Therefore, if it were shown that at the time of purchase there was a specific amount of capital invested in a specific tonnage, the purchaser would be entitled to a return of such investment in the way of depletion charges, irrespective of additional tonnage which at the beginning may have been undeveloped and in effect is not reflected in any capital investment whatever.