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afford a reasonable expectation of at least returning the capital invested in such well through the sale of the oil or gas, or both, to be derived therefrom.

(2) A proven tract or lease may be a part or the whole of a proven area. A proven area for the purposes of this statute shall be presumed to be that portion of the productive sand or zone or reservoir included in a square surface area of 160 acres having as its center the mouth of a well producing oil or gas in commercial quantities. In other words, a producing well shall be presumed to prove that portion of a given sand, zone or reservoir which is included in an area of 160 acres of land, regardless of private boundaries. The center of such square area shall be the mouth of the well, and its sides shall be parallel to the section lines established by the United States system of public land surveys in the district in which it is located. Where a district is not covered by the United States Land surveys, the sides of said area shall run north and south, east and west.

So much of a taxpayer's tract or lease which lies within an area proven either by himself or by another is "a proven tract or lease" as contemplated by the statute, and the discovery of a well thereon will not entitle such taxpayer to revalue such well for the purpose of depletion allowances, unless the tract or lease had been acquired before it became proven. And even though a well is brought in on a tract or lease not included in a proven area as heretofore defined, nevertheless it may not entitle the owner of the tract or lease in which such well is located to revaluation for depletion purposes, if such tract or lease lies within a compact area which is immediately surrounded by proven land, and the geologic structural conditions on or under the land so inclosed may reasonably warrant the belief that the oil or gas of the proven areas extends thereunder. Under such circumstances the entire area is to be regarded as proven land.

(3) The "property" which may be valued after discovery is the "well.” For the purposes of these sections the "well" is the drill hole, the surface necessary for the drilling and operation of the well, the oil or gas content of the particular sand, zone or reservoir (limestone, breccia, crevice, etc.) in which the discovery was made by the drilling and from which the production is drawn, to the limit of the taxpayer's private bounding lines, but not beyond the limits of the proven area as heretofore provided.

(4) A taxpayer to be entitled to revalue his property after March 1, 1913, for the purpose of depletion allowances must make a discovery after said date and such discovery must result in the fair market value of the property becoming disproportionate to the cost. The fair market value of the property will be deemed to have become disproportionate to the cost when the output of such well of oil or gas affords a reasonable expectation of returning to the taxpayer an

amount materially in excess of the cost of the land or lease if acquired since March 1, 1913, or its fair market value on March 1, 1913, if acquired prior thereto, plus the cost of exploration and development work to the time the well was brought in. [Art. 220 (a), as added by T. D. 2956, December 2, 1919.]

.... the taxpayer will be required .... to submit the following ....: (a) a map of convenient scale, showing the location of the tract and discovery well in question and of the nearest producing well, and the development for a radius of at least three miles from the tract in question, both on the date of discovery and on the date when the fair market value was set; (b) a certified copy of the log of the discovery well showing the location, the date drilling began, the date of completion and beginning of production, the formations penetrated, the oil, gas and water sands penetrated, the casing record, including the record of perforations, and any other information tending to show the condition of the well and the location of the sand or zone from which the oil or gas is produced on the date the discovery was claimed; (c) a sworn record of production, clearly proving the commercial productivity of the discovery well; (d) a sworn copy of the records, showing the cost of the property; and (e) a full explanation of the method of determining the value on the date of discovery or within 30 days thereafter, supported by satisfactory evidence of the fairness of this value. (Art. 221, as amended by T. D. 2956, December 2, 1919.)

Charges to capital and to expense in the case of oil and gas wells.

REGULATION. Such incidental expenses as are paid for wages, fuel, repairs, hauling, etc., in connection with the exploration of the property, drilling of wells, building of pipe lines, and development of the property may at the option of the taxpayer be deducted as an operating expense or charged to the capital account returnable through depletion. If in exercising this option the taxpayer charges these incidental expenses to capital account, in so far as such expense is represented by physical property it may be taken into account in determining a reasonable allowance for depreciation. The cost of drilling nonproductive wells may at the option of the operator be deducted from gross income as an operating expense or charged to capital account returnable through depletion and depreciation as in the case of productive wells. An election once made under this option will control the taxpayer's returns for all subsequent years. Casing-head gas contracts have been construed to be tangible assets and their cost may be added to the capital account returnable through depletion, following the rate set by the oil wells from which the gas is derived, or, if the life of the contract is shorter than the reasonable expectation of the life of the wells furnishing the gas, the capital invested in the contract may be written off through yearly allowances equitably distributed over the life of the contract. All oil produced during the taxable year, whether sold or unsold, must be considered in the computation of the depletion allowance for that year. In computing net income all oil in storage at the beginning. and at the end of the taxable year must be inventoried at cost, that is, unit cost plus lifting cost. Where deductions for depreciation or depletion have either on the books of the taxpayer or in his returns of net income been included in the past in expense or other accounts, rather than specifically as depreciation or depletion, or where capital expenditures have been charged to expense in lieu of depreciation or depletion, a statement indicating the extent to which this practice has been carried should accompany the return. (Art. 223.)

DEPRECIATION OF EQUIPMENT IN THE CASE OF OIL AND GAS WELLS.—

REGULATION. Both owners and lessees operating oil or gas properties will, in addition to and apart from the deduction allowable for the depletion or return of capital as hereinbefore provided, be permitted to deduct a reasonable allowance for depreciation of physical property, such as machinery, tools, equipment, pipes, etc., so far as not in conflict with the option exercised by the taxpayer under article 223. The amount deductible on this account shall be such an amount based upon its cost or fair market value as of March 1, 1913, equitably distributed over its useful life as will bring such property to its true salvage value when no longer useful for the purpose for which such property was acquired. Accordingly, where it can be shown to the satisfaction of the Commissioner that the reasonable expectation of the economic life of the oil or gas deposit with which the property is connected is shorter than the normal useful life of the physical property, the amount annually deductible for depreciation may for such property be based upon the length of life of the deposit. .... (Art. 225.)

Depletion and depreciation of oil and gas wells in years before 1916.—

REGULATION. If upon examination it is found that in respect of the entire drilling cost of wells, including physical property and incidental expenses, between March 1, 1913, and December 31, 1915, a taxpayer has been allowed a reasonable deduction sufficient to provide for the elements of exhaustion, wear and tear, and depletion, it will not be necessary to reopen the returns for years prior to 1916 in order to show separately in these years the portions of such deduction representing depletion and depreciation, respectively. Such

separation will be required to be made of the reserves for depreciation at January 1, 1916, and proper allocation between depreciation and depletion must be maintained after that date. In any case in which it is found that the deductions taken between March 1, 1913, and December 31, 1915, are not reasonable, amended returns may be required for these years. .... (Art. 226.)

Criticism of the regulations.—The expressed purpose of the law is to permit annual allowances for depletion, based on output, up to the cost of the wells, and the intention of the numerous rulings and regulations has been to carry out the provisions of the law. The most that any owner can desire to charge off against income is the fair value of the property March 1, 1913, or the entire cost of property acquired or the fair value of discoveries since that date. He recognizes that any net income realized in excess of such amount is profit and should be taxable.

In some cases owners desire to charge off too much annually and in other cases they do not charge off enough. Those who charged off too much prior to January 1, 1917, regret their action as there is now so much less left to claim as allowable deductions under laws levying higher taxes. On the other hand, conservative financing and accounting require liberal reserves for depreciation and depletion, and the concern which has followed this policy should continue it and make such adjustments between the books and the tax returns as will reflect the true state of affairs. An oil company with a large cash investment cannot afford to ignore depletion or exhaustion. Aside from new purchases, it is obvious that at the end of any period the product remaining in the ground is less than at the beginning of the period by exactly the amount which has been extracted.

New wells brought in may increase flow and there may be an apparent appreciation in values rather than depreciation, but when such hazardous properties as oil wells are under consideration the tendency of good managers is to be pessimistic about the future and to be liberal in depletion reserves. This policy prevents overstatement of assets and the payment of excessive dividends. It may save a company from bankruptcy. The government will not lose anything in taxes in the long run by permitting liberal depletion deductions. It will probably gain, because the instant the entire investment is written off the books no further deductions for depletion can be claimed and under graduated income and excess profits tax laws the aggregate tax is increased. From the taxpayer's point of view, it is better to pay too much tax in the long run and have a conservative balance sheet, than to ignore depletion or provide insufficient reserves and publish misleading balance sheets.

Timber-Forest Industries Regulations in regard to forest industries are comprehensive and are reproduced in full except when the provisions are the same as for mines, etc.

The Treasury has issued a questionnaire (form T) consisting of 36 pages which should be in the hands of all who are interested in the valuation or taxation of forest industries.

Depletion of timber.

REGULATION. A reasonable deduction from gross income for the depletion of timber 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 1, 1913, if acquired prior thereto. The essence of this provision is that the owner of timber property, whether it be a leasehold or a 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 its fair market value as of March 1, 1913, plus in any case the subsequent cost of plant, equipment and development which is not chargeable to current operating expenses, but not including cut-over land values. (Art. 227.)

COMPUTATION OF ALLOWANCE FOR DEPLETION OF TIMBER.

REGULATION. An allowance for the depletion of timber in any taxable year shall be based upon the number of feet of stumpage cut during the year and the unit cost of the stumpage at the date of

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