OPINION
GOFFE, Judge:*The Commissioner determined the following deficiencies in petitioners’ Federal income taxes for the taxable years 1978 and 1979:
Petitioner Taxable year Deficiency
H. J. and Josephine W. Freede 1978 $105,758/53
1979 551,348.33
Roger S. and Mary M. Folsom 1978 8,056.00
1979 97,444.00
The two cases, docket Nos. 16339-82 and 20768-82, were consolidated for trial, briefing, and opinion. The parties have settled numerous adjustments determined by the Commissioner in the statutory notices of deficiency. The sole issue for decision is whether petitioners are required to include in taxable income for the taxable year 1979 amounts received from Oklahoma Gas & Electric (hereinafter referred to as OG & E) pursuant to a “take or pay” Gas Purchase Contract.
All of the facts have been stipulated and the consolidated case was submitted to this Court without trial pursuant to Rule 122.1 The stipulations of facts and accompanying exhibits are so found and incorporated by reference.
At the time of filing the petitions in this case, H.J. and Josephine W. Freede, husband and wife, and Roger S. and Mary M. Folsom, husband and wife, resided in Oklahoma City, Oklahoma. Petitioners H.J. and Josephine W. Freede filed timely joint Federal income tax returns for the taxable years 1978 and 1979 with the Internal Revenue Service Center in Austin, Texas. Petitioners Roger S. and Mary M. Folsom filed timely joint Federal tax returns for the taxable years 1978 and 1979 with the Internal Revenue Service Center in Austin, Texas. Josephine W. Freede and Mary M. Folsom are parties in this case solely because they filed joint returns with their husbands. H.J. Freede (Freede) and Roger S. Folsom (Folsom) will be referred to jointly as petitioners.
During the taxable years at issue, petitioners were each, in addition to their other income producing activities, in the business of producing oil and gas. They carried out their business by purchasing fractional working interests in various mineral leases, which were then developed and operated by others. They each had adopted and used the cash receipts and disbursements method of accounting.
During the taxable years at issue, Freede and Folsom held working interests in Endicott No. 1 lease in Blaine County, Oklahoma, of .04362 percent and .013672 percent, respectively. The production from the lease consisted principally of natural gas.
On or about October 28, 1975, a gas purchase contract for the production of natural gas from the Endicott No. 1 lease was entered into between OG & E as purchaser and An-Son Corp. as seller. On or about January 14, 1976, a gas purchase contract for the production of natural gas from the Endicott No. 1 lease was entered into between OG & E as purchaser and A. Ben Chadwell and Julie Racz as seller. Although neither Folsom nor Freede appeared on either contract as parties, both petitioners were bound by, performed, and received performance as sellers under the terms of the contracts. The terms of both contracts are virtually identical, with the exception of slight differences such as the local base prices. All references to the contracts, purchaser, or seller for the remainder of this opinion refer to both contracts and the parties to both contracts, collectively.
The primary terms of the contracts were for 20 years. All of the gas produced and saved from the lease, with minor reservations, was sold to the purchaser.2 The contracts required that the seller make 100 percent of the deliver-ability3 of each well covered by the lease available to the purchaser. The contracts also included a “take or pay” provision which required the purchaser to pay for 80 percent of the deliverability of each well covered by the lease, regardless of whether the purchaser took physical delivery of any gas at all.4 The amount of gas or substituted payment under the “take or pay” obligation was also referred to as the minimum contract quantity. The seller was obligated to maintain deliverability of 125 percent of the minimum contract quantity.
Under the contracts, if the amounts paid in any taxable year exceeded the amounts attributable to the gas actually taken, OG & E was entitled to an offset for the excess payments in subsequent years to the extent that the gas taken in later years exceeded the minimum contract quantity. Thus the purchaser was not obligated to pay for the gas taken in future years until the value of the gas taken exceeded both the minimum contract quantity payments for that year and the excess payments made in earlier years. So long as the purchaser continued to make minimum payments, the contracts did not require that the purchaser take even a minimum of gas in any particular year. If the payments exceeded the value of the gas taken, however, the purchaser’s only right of recoupment was from the production of gas in excess of the minimum contract quantities in future years. The purchaser’s right of recoupment or recovery was protected, however, by the fact that OG & E could require that the seller produce gas in an amount equal to 100 percent of the deliverability of each well covered by the lease, or 25 percent in excess of the minimum contractual amounts.
Pursuant to the contracts, the purchaser made the minimum payments to the seller in the taxable year 1979 calculated with reference to 80 percent of the deliverability of each well covered by the lease, as set forth by the contracts. A portion of the payment was for gas actually taken under the contracts. As the amount of gas taken was not equal to or more than the minimum contract quantity, a portion of the minimum contract amount paid under the terms of the contracts was for the difference between the gas taken and the minimum contract quantity of gas. Under the terms of the contracts, OG & E was, therefore, not obligated to pay for gas taken in subsequent years in excess of the minimum contract rate until the amounts paid in 1979 were offset by the additional gas taken. In 1979, the lease had sufficient projected reserves to repay OG & E in gas, prior to the expiration of the contracts, for the contractual minimum payments paid for gas not taken.
As owners of portions of the working interest, Freede and Folsom received payments from OG & E in the taxable year 1979 in the respective amounts of $462,881.30 and $205,963.44. The amounts received represented both payments for gas actually taken by OG & E and payments for the difference between the amount OG & E was contractually obligated to pay for and the volume of gas actually taken. The respective amounts are as follows:
Type of payment Freede Folsom
Payments for gas taken $119,626.14 $64,802.26
Payment for the difference between minimum contractual payment and payment made for gas taken 343,255.16 141,161.18
Total payments to petitioners 205,963.44 462,881.30
The amounts representing payments for gas actually taken by OG & E were included as income by petitioners on their respective Federal income tax returns for the taxable year 1979. The payments made pursuant to the contractual minimum that represented advance payments for gas not taken were not included by either petitioner as income for the taxable year 1979. Both petitioners decided to include in income for later taxable years payments for gas taken by OG & E during those years in excess of the minimum contract quantity.
Petitioners contend that the advance payments received under the “take or pay” contracts with OG & E create an economic interest entitling OG & E to production payments under section 636(a). If the advance payments are an investment in future production, the minimum contract payments paid for gas not taken in 1979 would be treated as loans from OG & E to petitioners, with income recognized only when the gas is actually delivered in subsequent years. Respondent contends that the entire amounts received from OG & E constitute realized income which should be recognized under section 61(a) and section 451,5 citing Rev. Rul. 80-48, 1980-1 C.B. 99.
A production payment, in general terms, is a right to minerals in place that entitles its owner to a specified share of production for a limited time from a specified mineral property when production occurs. Sec. 1.636-3(a)(l), Income Tax Regs.; see H. Rept. 91-413 (1969), 1969-3 C.B. 200; S. Rept. 91-552 (1969), 1969-3 C.B. 423; F. Burke & R. Bowhay, Income Taxation of Natural Resources, par. 2.07, at 206 (1985). A “carved-out” production payment arises where the owner of an interest in a mineral property assigns a production payment to another person but retains his interest in the property from which the production payment is assigned. If such a production payment is created, section 636(a) describes the tax consequences:
SEC. 636(a). CaRVED-out PRODUCTION Payment. — A production payment carved out of mineral property shall be treated, for purposes of this subtitle, as if it were a mortgage loan on the property, and shall not qualify as an economic interest in the mineral property. * * *
It is important to the discussion which follows to point out that section 636(a) and the regulations thereunder require first that the production payment be an actual economic interest, and then that the production payment be treated as a loan for Federal income tax purposes rather than the economic interest that it is.
Sections 1.636-3(a)(l) and (2), Income Tax Regs., further define the term “production payment”:
(a) Production payment. (1) The term “production payment” means, in general, a right to a specified share of the production from mineral in place (if, as, and when produced), or the proceeds from such production. Such right must be an economic interest in such mineral in place. It may burden more than one mineral property, and the burdened mineral property need not be an operating mineral interest. Such right must have an expected economic life (at the time of its creation) of shorter duration than the economic life of one or more of the mineral properties burdened thereby. A right to mineral in place which can be required to be satisfied by other than the production of mineral from the burdened mineral property is not an economic interest in mineral in place. A production payment may be limited by a dollar amount, a quantum of mineral, or a period of time. A right to mineral in place has an economic life of shorter duration than the economic life of a mineral property burdened thereby only if such right may not reasonably be expected to extend in substantial amounts over the entire productive life of such mineral property. The term “production payment” includes payments which are commonly referred to as “in-oil payments”, “gas payments”, or “mineral payments”.
(2) A right which is in substance economically equivalent to a production payment shall be treated as a production payment for purposes of section 636 and the regulations thereunder, regardless of the language used to describe such right, the method of creation of such right, or the form in which such right is cast (even though such form is that of an operating mineral interest). Whether or not a right is in substance economically equivalent to a production payment shall be determined from all the facts and circumstances. * * *
The production payment, is then, under the terms of section 636(a), treated as a loan, as set forth in section 1.636-l(a)(l) (ii), Income Tax Regs.:
The payer of a production payment treated as a loan pursuant to this section shall include the proceeds from (or, if paid in kind, the value of) the mineral produced and applied to the satisfaction of the production payment in his gross income and “gross income from the property” (see section 613(a)) for the taxable year so applied. The payee shall include in his gross income (but not “gross income from property”) amounts received with respect to such production payment to the extent that such amounts would be includible in gross income if such production payment were a loan. The payer and payee shall determine their allowable deduction as if such production payment were a loan. * * *
The treatment of the advance payments and the resultant tax consequences depend upon whether or not such payments are an investment in future production that create a production payment constituting an economic interest under sections 631 and 636. Applying the Code and regulations to this case, the question is whether the advance payments from OG & E to petitioners which create a right in OG & E to share in the future production of gas are, under section 636(a), treated as production payments. If so, then the payments to petitioners by OG & E would be characterized under section 636(a) as loans from OG & E to petitioners which would not be taxable to petitioners in the year before the Court.
The criteria that must be satisfied under the terms of the statutes and regulations set forth above are: (1) the purchaser must have a right to a specified share of production or the proceeds from such production; (2) the interest must have an expected economic life (at the time of its creation) of shorter duration than the economic life of the mineral property upon which it is a burden; (3) the right must be an economic interest in the mineral in place; (4) the interest must not be able to be satisfied by other than the production of mineral from the burdened mineral property; and (5) the production payment must be limited by either a dollar amount, a quantum of mineral, or a period of time. In this case, each of the criteria has been met.
The contracts provide that the purchaser is entitled to the entire production of the lease, and is required to take or pay for 80 percent of the deliverability of each well covered by the lease. The sellers agreed to maintain deliverability and production of each well at 100 percent, which is 125 percent of the minimum contract quantity. OG & E clearly has the right to a specified share of the production from the lease, thus satisfying the first criterion.
The second criterion has also been met in that OG & E can recoup the amounts paid for gas not received from the projected reserves prior to the termination of the contracts. The economic life of the interest created by the advance payments is thus limited to the terms of the contracts, which are shorter than the economic life of the property.
The third criterion, however, is the principal point upon which the parties disagree. In order for the advance payments to be treated as an investment in future production by OG & E rather than as income to petitioners, payments made pursuant to the contracts must create a depletable economic interest as defined in section 1.611-1(b)(1), Income Tax Regs.:
An economic interest is possessed in every case in which the taxpayer has acquired by investment any interest in mineral in place or standing timber and secures, by any form of legal relationship, income derived from the extraction of the mineral or severance of the timber, to which he must look for the return of his capital. For an exception in the case of certain mineral production payments, see section 636 and the regulations thereunder. A person who has no capital investment in the mineral deposit or standing timber does not possess an economic interest merely because through a contractual relation he possesses a mere economic or pecuniary advantage derived from production. For example, an agreement between the owner of an economic interest and another entitling the latter to purchase or process the product upon production or entitling the latter to compensation for extraction or cutting does not convey a depletable economic interest. * * *
Petitioners contend that OG & E acquired an economic interest in the gas in place by virtue of the rights and obligations under the “take or pay” contracts. Respondent argues the converse, proposing that OG & E had merely a contractual right to receive the gas, not a property interest in the gas itself; OG & E had at best an “economic advantage,” not an “economic interest.”
Although section 1.611-l(b), Income Tax Regs., purports to adequately define the term “economic interest,” a number of cases have expanded upon the vague meaning of the term. Even the courts, however, have found it difficult to single out one recurring factor that clearly indicates ownership of an economic interest in the minerals in place. Tidewater Oil Co. v. United States, 168 Ct. Cl. 457, 339 F.2d 633 (1964).
The purchaser need not have legal title to the property to have an economic interest:
It is enough if, by virtue of the leasing transaction, he has retained a right to share in the oil produced. If so he has an economic interest in the oil, in place, which is depleted by production. * * * [Palmer v. Bender, 287 U.S. 551, 557 (1933).]
A taxpayer has an “economic interest” in minerals regardless of the legal form of the interest if he has acquired the interest by investment in the minerals in place, and looks to the extraction of the minerals for the return of his investment. Gulf Oil Corp. v. Commissioner, 86 T.C. 115, 136 (1986); Thomas v. Perkins, 301 U.S. 655, 661 (1937). See also Weaver v. Commissioner, 72 T.C. 594 (1979).
For an interest to be an economic interest within the terms of section 636(a), the payments must be in exchange for the receipt of minerals and there must also be an investment in the production of the minerals. Gibson Products Co. v. United States, 637 F.2d 1041 (5th Cir. 1981); Weaver v. Commissioner, supra. Thus, where the taxpayer was merely a processor of oil and was not engaged in production, the taxpayer had no interest in the mineral in place. The fact that the taxpayer obtained an economic advantage from the production of the gas was not adequate basis for the creation of an economic interest. Helvering v. Bankline Oil Co., 303 U.S. 362, 367-369 (1938). “The test * * * is whether the taxpayer has a capital investment in the oil in place which is necessarily reduced as the oil is extracted.” Kirby Petroleum Co. v. Commissioner, 326 U.S. 599, 603 (1946). “Economic interest does not mean title to the oil in place but the possibility of profit from that economic interest dependent solely upon the extraction and sale of the oil.” Kirby Petroleum Co. v. Commissioner, supra at 604; Gulf Oil Corp. v. Commissioner, supra.
Although the cases cited above repeatedly conclude that title is not required as a prerequisite to an economic interest, no taxpayer was found to possess an “economic interest” who did not also hold either a fee interest or a leasehold interest in the mineral property until Commissioner v. Southwest Exploration Co., 350 U.S. 308 (1956). The taxpayers were fee owners of upland adjoining property that the State of California required that the operator use for access, by means of slant drilling, to the offshore mineral properties. The taxpayers granted the operator the right to drill in exchange for a net profits interest, and subsequently claimed depletion on the amounts received. The Supreme Court held that the taxpayers, although neither owners of the fee interest nor lessors of the minerals, had an “economic interest” upon which they were entitled to depletion. In so holding, the Court held:
It is true that the exclusive right to drill was granted to Southwest, and it is also true that the agreements expressly create no interest in the oil in the upland owners. But the tax law deals in economic realities, not legal abstractions, and upon closer analysis it becomes clear that these factors do not preclude an economic interest in the upland owners. [350 U.S. at 315.]
Respondent contends that the facts of this case are indistinguishable from Helvering v. Bankline Oil Co., supra. In that case, the taxpayer was merely a processor of the mineral and possessed no other rights whatsoever with respect to the mineral in place. The Supreme Court found that Bankline was afforded only “economic advantage” by virtue of the contract, rather than an economic interest in the minerals in place. 303 U.S. at 367. Respondent argues that OG & E also has no more than an economic advantage derived from the mere processing of the minerals made available to it under the contracts. Respondent’s conclusion is that OG & E cannot, therefore, satisfy the third requirement for a production payment under section 636 because an economic advantage is not equivalent to an economic interest.
Petitioners argue that OG & E’s interest in the production of gas from the lease rises to the level of an economic interest, due to the contractual rights and obligations of OG & E. We agree with petitioners.
Under the contracts, OG & E has the obligation to take or pay for 80 percent of the deliverability of each well covered by the lease. OG & E, however, also has the right to require the producers to maintain production equal to 100 percent of the deh ver ability of each well, or an amount equal to 125 percent of the minimum contract quantity. If OG & E pays an amount in excess of the value of gas actually taken, it has the right to offset the payments against any amounts produced in subsequent years in excess of the applicable minimum contract quantity. OG & E, in essence, has both rights to the minerals in place and a means of controlling production. Although OG & E did not have legal title to the minerals, title is not the controlling factor. Kirby Petroleum, Co. v. Commissioner, supra at 604. When the rights and obligations of OG & E under the contracts are viewed in their entirety, they rise to the equivalent of an economic interest under the statute, regulations, and case law.
The fourth factor that must be satisfied under section 1.636-3(a)(l), Income Tax Regs., for the payments to be treated as production payments is that the advance payments must be satisfied only from the production of mineral from the burdened property. Under the contracts, OG & E pays an amount each year equal to 80 percent of the deliverability of each well covered by the lease, whether or not it takes the minimum contract quantity of gas. The only method by which OG & E can obtain value for the payments made is to take an additional amount of gas over the minimum contract quantity in future years. Further, the sellers are required to produce the gas which will repay OG & E for the amounts previously paid. OG & E has no other source for repayment other than the future production of gas from the lease specified in the contracts. The fourth criterion has been satisfied.
The final criterion is that the production payment must be a specified share of production limited by either a dollar amount, a quantum of mineral, or a period of time. In this case, the contracts provide that the advance payments are the equivalent of advance payment for gas to be received later. In each year, OG & E must take or pay for 80 percent of the deliverability of the wells. In years when OG & E takes gas that it has previously paid for, that deliverability must come from the remaining 20 percent of production. Only the excess production above that amount can be used for recoupment of the advance payments. OG & E can, however, compel production of that final 20 percent of production, otherwise defined as 125 percent of the minimum contract quantity. The amount of gas delivered is limited by the maximum amount of deliverability that can be imposed by OG & E, and is further limited by the fact that the contracts have a 20-year term within which OG & E must, if at all, recoup the advance payments from production. The fifth criterion is also satisfied under the facts of this case, and the requirements for a production payment as set forth in the statute and regulations thereunder have been met.
Respondent’s final argument, however, is that Rev. Rul. 80-48, 1980-1 C.B. 99, sets forth the proper approach toward “take or pay” gas contracts and that such contracts create no more than an economic advantage. Rev. Rul. 80-48, supra, describes a “take or pay” gas purchase contract similar to the factual situation here: Y purchases a specified amount of gas from the taxpayer each month, but pays whether or not Y chooses to take the entire monthly production. Any advance payments made by Y create a right to future excess production without additional payment. The authors of the revenue ruling conclude that:
An agreement between the owner of an economic interest and another entitling the latter to purchase the product upon production does not convey a depletable economic interest in mineral in place.
The taxpayer, in this case, entered into an agreement with Y under the terms of which Y must purchase each month, for the life of the contract, a specified amount of gas. However, Y need not take the gas. Under the provisions of section 1.611-l(b) of the regulations such an agreement does not convey a depletable economic interest in mineral in place.
[1980-1 C.B. at 99-100.]
A revenue ruling is no more than a statement of the Commissioner’s position, and is “not entitled to any particular weight.” Anselmo v. Commissioner, 80 T.C. 872, 883 n. 13 (1983), affd. 757 F.2d 1208 (11th Cir. 1985). The Fifth Circuit has further described the value of a revenue ruling:
A ruling is merely the opinion of a lawyer in the agency and must be accepted as such. It may be helpful in interpreting a statute, but it is not binding on the Secretary or the courts. It does not have the effect of a regulation or a Treasury Decision. [Stubbs, Overbeck & Associates, Inc. v. United States, 445 F.2d 1142, 1146-1147 (5th Cir. 1971).]
The support offered for the conclusion drawn in the revenue ruling is section 1.611-l(b), Income Tax Regs., which provides that an agreement for purchase upon production is not a conveyance of a depletable economic interest in mineral in place.6 As pointed out above, however, the “take or pay” contracts at issue in this case are not merely agreements to purchase if production occurs. OG & E has a right of recoupment for the advance payments limited solely to future production of minerals and may compel production to satisfy the recoupment rights created by the advance payments. In essence, the purchaser has acquired by investment (the advance payments) an interest in the gas in place, which may be satisfied solely from the minerals extracted, thus fulfilling the definition of an economic interest under section 1.611-l(b)(i), Income Tax Regs.
We hold that a production payment as defined by section 1.636-3(a), Income Tax Regs., has been created, and the payments received in 1979 in excess of payments for gas delivered, are not taxable in 1979.
Decisions will be entered under Rule 155.
Reviewed by the Court.
Sterrett, Simpson, Chabot, Parker, Whitaker, Hamblen, Cohen, Clapp, Swift, and Wright, JJ., agree with the majority opinion. Wilbur, Korner, Shields, and Gerber, JJ., did not participate in the consideration of this case.By order of the Chief Judge, this case was reassigned from Judge Charles E. Clapp II, to Judge William A. Goffe.
All Rule references are to this Court’s Rules of Practice and Procedure. All statutory references are to the Internal Revenue Code of 1954 as amended and in effect during the taxable years in issue.
The price paid was set with reference to a local base price, escalating 1 cent per thousand cubic feet each year thereafter, subject to adjustments upwards or cancellation of the contract under certain circumstances.
“Deliverability” is defined in the contracts as the volume of gas attributable to Seller’s gas reserves actually delivered to Buyer at the point of delivery against the required delivery pressure during the 24-hour period following delivery of gas at the maximum rate of flow from Seller’s wells against the required delivery pressure for a period of 3 days. For convenience, that term will be used in this opinion although, in general terms, it could describe “production” from the wells.
The “take or pay” obligation was reduced in the event that the seller was unable to maintain normal deliverability. In that case, the purchaser was required only to take or pay for 80 percent of the production actually made available to the purchaser.
Sec. 61(a) provides that gross income includes all income from whatever source derived. Sec. 451(a) provides that:
The amount of gross income shall be included in the gross income for the taxable year in which received by the taxpayer, unless under the method of accounting used in computing taxable income, such amount is to be properly accounted for as of a different period.
This revenue ruling has been discussed and in some cases criticized in oil and gas taxation texts and periodicals. See 2 L. Fiske, Federal Taxation of Oil & Gas Transactions, sec. 8.12 (1983); 1 Energy Resources Tax Reports (CCH) pars. 651-653 (1983); C. Russell & R. Bowhay, Income Taxation of Natural Resources (P-H), par. 15.15, at 1519-1520 (1986); A. Bruen & W. Taylor, Federal Income Taxation of Oil & Gas Investments, par. 8.07[6][a] (1983 & Supp. 1985); Emery, “Current Developments in Oil and Gas Taxation,” 32d Ann. Inst, on Oil & Gas L. & Taxation 335, 352-353 (1981); Hasche, Crump & Huggins, “Mineral Production Payments; Gas ‘Take or Pay’ Purchase Contract,” 28 Oil & Gas Tax Quarterly 564 (1981); Burke & Karpen, “New Revenue Ruling 80-48: A Blueprint for Recreating Carved-out Production Payments?” 53 J. Taxation 370 (1980).