United States

Tax Court rules on proportionate-profits depletion for mined minerals

TAX ALERT  | 

When a taxpayer engages in certain mining activity they are entitled to a depletion deduction under §611. [1] Taxpayers determine the deduction as a percentage of gross sales on related mining activity. To the extent the taxpayer has qualified mining activity and nonqualified activity it is important to correctly determine the various inputs to accurately determine the deduction.

On Aug. 21, 2017, the U.S. Tax Court decided Mitsubishi Cement Corp. V. Comm'r, T.C. Memo 2017-160, a case involving the proportionate profits method of depletion for calcium carbonate mines. As applied to the taxpayer in Mitsubishi, the appropriate depletion deduction under the proportionate profits method is determined as follows:

 

Depletion rate

x

(

Mining costs

x

Gross Sales

)

=

Depletion deduction

Total costs

     

Gross Income from Mining

     

 

The specific issues under consideration in Mitsubishi were the following:

1.    Whether the taxpayer, a cement manufacturer mining calcium carbonate, could rely upon the depletion rate for calcium carbonate mines provided in Treas. Reg. §1.613‑2(a)(3), a rate of 15%, or must use instead the 14% rate provided in §613(b)(7); and

2.    Whether the purchase price of additive materials, when mixed with the mined minerals prior to the kiln process, are included as “mining costs” or rather “total costs” for purposes of the proportionate profits calculation.

The Court decided the first issue, the applicable depletion rate, based solely on a weight of authority analysis. Treas. Reg.§1.613-2(a)(3), which the taxpayer had relied upon in applying a 15% rate, was promulgated by the Treasury prior to a drop in the statutory rate for the category of minerals that includes calcium carbonate to 14%. That portion of the regulation was, therefore, superseded and made obsolete by the change made to the underlying statute. However, the Court also noted that even if the timing of the regulation was not at issue, the broad deference generally granted to agency regulations under Chevron, U.S.A., Inc. v. Nat. Res. Def. Council, Inc., 467 U.S. 837, 843 (1984) does not apply when those regulations directly conflict with the “unambiguously expressed intent of Congress.” Since §613(b)(7) clearly states that the applicable depletion rate for calcium carbonate is 14%, the taxpayer could not rely on the conflicting rate provided in the regulations.

The second issue, the proper classification of the purchase price of additive materials, involved the scope of “mining costs” used in the ratio applied to gross receipts to arrive at gross income from mining activities. Because the additives at issue in Mitsubishi were mixed with the calcium carbonate prior to the introduction of the minerals into the kiln, the taxpayer attempted to classify their purchase price as a “treatment process” allowable as a mining expense under §613(c)(4)(F). The mining expenses allowed under §613(c)(4)(F) include “all processes (other than preheating of the kiln feed) applied prior to the introduction of the kiln feed into the kiln, but not including any subsequent process.” The Tax Court rejected the taxpayer’s argument, holding that the mere timing of the introduction of the additive materials did not bring their purchase price outside of the regulations’ specific prohibition against including such costs as mining expenses.

Specifically, Treas. Reg. §1.613-4(f)(2)(iv) provides that mining does not include either the purchase of materials from another or the applying of processes to such purchased materials. Additionally, Treas. Reg. §1.613-4(d)(3)(ii) provides that “a process shall not be considered as a mining process to the extent it is applied to . . . materials with respect to which the taxpayer is not entitled to a deduction for depletion under section 611. [Their] costs . . . shall be considered as nonmining costs in determining gross income from mining.”

While the Mitsubishi decision clarifies the full scope of the regulatory prohibition against treating additive materials as mining costs, the analysis contained within also underscores the importance of understanding the proper interaction between statute and regulation. Where a statute is specific and clear, a taxpayer cannot rely on a regulation that stands in direct conflict. Conversely, where a statute is broad or ambiguous, a taxpayer cannot ignore a properly issued regulatory interpretation of it. Please consult your advisors to make sure your maximizing the deduction without subjecting yourself to IRS examination risk.

[1] Unless otherwise indicated by the context, references herein to “section” or “§” are to provisions of the Internal Revenue Code of 1986 (“Code”), and references applicable Treasury Regulations.

AUTHORS


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