1954 U.S. Tax Ct. LEXIS 178">*178 Decision will be entered under Rule 50.
Petitioner, the owner of coal properties, entered into contracts with various companies for mining its coal at a specified price per ton. Held, the independent contractors had no economic interest in the coal in place and the amounts paid to them are not to be excluded from petitioner's gross income in the computation of depletion deductions for the taxable years involved. Morrisdale Coal Mining Co., 19 T.C. 208, followed; James Ruston, 19 T.C. 284, and J. E. Vincent, 19 T.C. 501, revd. 212 F.2d 52, distinguished.
22 T.C. 571">*571 Respondent determined deficiencies in income tax for the fiscal years ended August 31, 1947, and August 31, 1948, in the amounts of $ 18,166.74 and $ 16,529.75, respectively.
The sole issue is whether, in determining the percentage depletion deduction for the taxable years involved, the respondent erred in reducing the petitioner's gross income by the amounts paid by it1954 U.S. Tax Ct. LEXIS 178">*179 to certain independent contractors engaged, by written and oral agreements, to extract coal from petitioner's properties at a specified price per ton.
The stipulated facts are found accordingly.
FINDINGS OF FACT.
The Mammoth Coal Company, petitioner herein, is a Pennsylvania corporation having its principal place of business at Raven Run, Pennsylvania. It is engaged in the mining, processing, and sale of anthracite coal. It kept its books and records on an accrual basis and filed its tax returns for each of the fiscal years ended August 31, 1947, and August 31, 1948, with the collector of internal revenue for the first district of Pennsylvania.
On September 13, 1946, petitioner acquired 1,200 acres of coal lands situate in the southern anthracite coal fields, Schuylkill County, Pennsylvania.
On December 10, 1946, petitioner entered into a written agreement with the Capparell Stripping & Construction Company, Inc., hereinafter referred to as Capparell. Under the agreement, Capparell was to strip mine certain coal veins on three tracts of land owned by petitioner. The area embracing the operations known as the Raven Run job had previously been deep mined and, in parts, had also 1954 U.S. Tax Ct. LEXIS 178">*180 been strip mined. The purpose of the strip mining operation was to salvage so much of the coal as remained after previous mining operations.
22 T.C. 571">*572 The agreement provided that Capparell was to excavate, remove, and dispose of all earth and rock, or overburden, overlying the coal veins in the three tracts, to recover all salvageable coal so exposed, and to deliver all material extracted from the veins to petitioner's cleaning plant, colliery, or other place designated by petitioner, at a specified price per ton.
The contract further provided:
4A. It is understood and agreed that the sole compensation to be paid by COAL COMPANY [petitioner] to CONTRACTOR [Capparell] hereunder for the performance of the obligations and acts set forth above, including the removal of overburden, recovery and loading of coal, and separation of coal from refuse materials as more fully defined in the next paragraph, deposits of refuse and delivery of coal recovered to COAL COMPANY as hereinafter set forth, shall be that which is comprehended in the provision hereinafter set forth fixing the price to be paid by COAL COMPANY to CONTRACTOR for coal delivered to COAL COMPANY.
4B. It is specifically understood1954 U.S. Tax Ct. LEXIS 178">*181 and agreed that when COAL COMPANY shall erect a cleaning plant all material removed from the veins shall be delivered to COAL COMPANY at said cleaning plant and CONTRACTOR shall receive the payments to which it is entitled hereunder upon the basis of the weight of the coal after it has been processed through said cleaning plant, it being understood and agreed that at all times during the term of this agreement the COAL COMPANY shall designate the places to which CONTRACTOR shall deliver the coal and shall likewise designate all places where the CONTRACTOR will deliver refuse for disposal. The cleaning plant shall be erected and operated by COAL COMPANY at its own expense.
When the cleaning plant has been erected and placed in operation the CONTRACTOR shall be paid in accordance with the following method: All material taken by CONTRACTOR from the veins shall be delivered by CONTRACTOR to the cleaning plant of COAL COMPANY and weighed before being deposited into the cleaning plant. After the material has been processed through the cleaning plant, the refuse and rock removed therefrom by CONTRACTOR, in accordance with this agreement, shall be weighed and deducted from the weight of1954 U.S. Tax Ct. LEXIS 178">*182 the material deposited in the cleaning plant, and CONTRACTOR shall be paid only on the basis of the tonnage of material deposited in cleaning plant, less the tonnage of rock and refuse removed therefrom in the cleaning process. COAL COMPANY shall pay to the CONTRACTOR the sum of $ 2.50 per gross ton (2240 lbs.) in accordance with the computation of tonnage set forth in this paragraph.
Until the cleaning plant has been erected, as aforesaid, CONTRACTOR shall be paid at the rate of $ 2.16 per gross ton (2240 lbs.) for all material delivered by CONTRACTOR to COAL COMPANY.
CONTRACTOR shall remove all refuse and rock from the cleaning plant without charge to COAL COMPANY, and shall at all times supply, at CONTRACTOR'S own cost and expense, sufficient trucks to remove said rock and refuse promptly and deliver it to dumping areas designated by COAL COMPANY.
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4D. All coal recovered by CONTRACTOR which, in the opinion of an authorized representative of COAL COMPANY, is acceptable to COAL COMPANY, shall be delivered to and deposited at THE MAMMOTH COAL COMPANY colliery or cleaning plant, as COAL COMPANY shall designate, at the sole cost 22 T.C. 571">*573 and expense of CONTRACTOR. All coal1954 U.S. Tax Ct. LEXIS 178">*183 so delivered and deposited shall be weighed at THE MAMMOTH COAL COMPANY cleaning plant or colliery as COAL COMPANY shall designate, by authorized representatives of COAL COMPANY and at the sole cost and expense of COAL COMPANY. All coal found unacceptable by COAL COMPANY shall be so designated in writing by an authorized representative of COAL COMPANY. CONTRACTOR, however, shall have the right to sell coal rejected by COAL COMPANY to any other person or persons as it may choose, subject, however, to the consent and approval of the OAK RIDGE COAL CORPORATION, its successors and assigns, Mortgagee of the premises described above, which said approval shall be first obtained before any sale of materials to persons, firms or corporations other than COAL COMPANY.
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4F. COAL COMPANY will not permit any mining, either surface or underground, within CONTRACTOR'S limits of work and depth of proposed cuts.
* * * *
11. COAL COMPANY shall furnish to CONTRACTOR each week a statement showing all coal delivered to and accepted by it at the colliery of COAL COMPANY (or at its cleaning plant after it commences to operate) and shall pay to CONTRACTOR each week for all coal so delivered and accepted1954 U.S. Tax Ct. LEXIS 178">*184 during the preceding week.
12. COAL COMPANY shall have the right to reject any coal or coal material delivered to it by CONTRACTOR, provided, however, that in such event CONTRACTOR shall have the right to dispose of the rejected coal in the manner provided in Paragraph 4D of this agreement.
* * * *
15. COAL COMPANY shall have the right to cancel this contract provided CONTRACTOR shall not truly keep and perform each and every of the foregoing covenants, conditions or requirements contained herein, which on CONTRACTOR'S part are to be kept and performed, which are the express considerations and conditions on which this contract is granted and on the keeping and performance of which its existence depends.
* * * *
18. COAL COMPANY shall take the coal loaded by CONTRACTOR only at such times as the breaker of said COAL COMPANY is in operation; that COAL COMPANY shall not be obligated to run said breaker for the purpose of receiving said coal, nor shall COAL COMPANY be liable to CONTRACTOR for failure to operate its breaker; and CONTRACTOR shall furnish COAL COMPANY with a minimum of 2500 tons per day excepting in the case of a strike or lock-out or any other condition beyond the control1954 U.S. Tax Ct. LEXIS 178">*185 of CONTRACTOR.
19. COAL COMPANY shall have the right to suspend work hereunder for an indefinite period, upon five (5) days notice to CONTRACTOR, without any liability to CONTRACTOR for damages, it being understood that after a continued suspension of five (5) weeks, at the request of COAL COMPANY, CONTRACTOR may consider this contract terminated if CONTRACTOR so elects, provided that CONTRACTOR gives notice, in writing, to that effect to COAL COMPANY, but if no such notice has been given, when COAL COMPANY desires a resumption of the work hereunder, if COAL COMPANY shall notify CONTRACTOR, in writing to resume work and CONTRACTOR shall fail, within fifteen (15) days so to resume, then COAL COMPANY may forthwith terminate this contract and let the work to other parties, holding CONTRACTOR responsible for any damage 22 T.C. 571">*574 resulting to COAL COMPANY and naturally arising from such breach of contract.
* * * *
22. It is mutually agreed that should the CONTRACTOR at any time default in the faithful performance of the covenants herein imposed upon it, then COAL COMPANY shall have the sole right of ownership in the material deposited in the stock banks and piles upon the premises, and1954 U.S. Tax Ct. LEXIS 178">*186 that all sums realized from the recovery and sale of such material shall become the sole and absolute property of COAL COMPANY, free of and discharged from any lien, claim or charge whatsoever in favor of the CONTRACTOR; and it is further agreed that CONTRACTOR shall not be privileged to remove from the premises any equipment reasonably necessary for the completion of the work contemplated herein; and that, in the event of any default, COAL COMPANY shall have the right to use any equipment and machinery of the CONTRACTOR upon the premises in the completion of the work herein contemplated and may retain possession of the same as security for any loss which COAL COMPANY may sustain by reason of any default of CONTRACTOR in its failure to faithfully fulfill and perform all and singular the covenants imposed upon it.
Petitioner had the right to cancel the contract if Capparell became involved in bankruptcy or similar proceedings, failed to prosecute the work with an adequate force, failed to comply with petitioner's directions, or neglected the requirements of the contract. In any such event petitioner reserved the right immediately to enter upon and for its own use to take possession1954 U.S. Tax Ct. LEXIS 178">*187 of the premises occupied by the contractor, together with all improvements, machinery, and property used thereon. In such event the cash value of the property would be ascertained through arbitration and petitioner would pay the sum so determined to Capparell. Petitioner reserved the right to require Capparell to remove the machinery, equipment, and improvements. In the event the latter failed to do so within 180 days from service of notice to remove, then title to such unremoved property would pass to petitioner.
The agreement of December 10, 1946, was modified by supplemental agreements dated July 28, 1947, and August 27, 1947, under which the rates of payment per ton were increased to $ 2.63 and $ 3.03, respectively. The second of these increases was in consideration of Capparell's replacing certain types of its existing equipment with certain specified new equipment and Capparell's assurance that the new equipment would result in a more efficient operation, including an increase in the coal recovered to a minimum of 60 per cent of the net tonnage delivered to petitioner's breaker. The cost to Capparell of the specified new equipment was $ 269,258.44.
Subsequently, by oral1954 U.S. Tax Ct. LEXIS 178">*188 agreements later confirmed in writing by petitioner on May 7, 1948, and August 19, 1948, the contract price per ton of material delivered to the breaker was increased first to $ 3.15 and 22 T.C. 571">*575 then to $ 3.30. In all other respects the original agreement of December 10, 1946, remained unchanged and in full force and effect. On April 15, 1949, petitioner and Capparell mutually released each other from the terms of their agreement, as amended.
During the taxable years involved petitioner paid all real estate taxes on the coal lands, employed watchmen to guard the property, and paid for power, including that used by Capparell.
Pursuant to its obligation to provide necessary buildings, equipment, and machinery for the coal stripping operation, Capparell erected buildings on the Raven Run job at a cost of $ 4,842.72. It also provided new equipment and machinery especially for the performance of the work contemplated by the contract, as amended, at a cost of $ 791,590.88. In addition, as of December 10, 1946, Capparell had on hand machinery and equipment having a cost basis of $ 179,302.27, which was also used in fulfillment of its contractual obligations.
During the fiscal year 1954 U.S. Tax Ct. LEXIS 178">*189 ended August 31, 1947, petitioner's gross income from sales of coal mined under the agreement with Capparell was $ 1,369,719.10. During that period Capparell received the total sum of $ 655,929.03 from petitioner pursuant to the agreement.
During the fiscal year ended August 31, 1947, petitioner paid royalties to the Hazle Brook Coal Company, mortgagee of the coal lands, in the amount of $ 2,444.60.
During the fiscal year ended August 31, 1948, petitioner entered into oral contracts with several small mining companies, namely, Hillside Mining Company, the Big Buck Mining Company, and the North Basin Coal Mining Company, for the purpose of deep mining petitioner's coal lands. These companies were not related directly or indirectly to Capparell, and the area of their operations was not included in the area covered by the written contract of December 10, 1946, as amended, but was distinct and apart therefrom.
Under the terms of the oral agreements the contractors were paid by petitioner at a fixed rate per ton for material delivered to petitioner's breaker. The agreements were terminable by petitioner at will and were summarily terminated, in the case of Hillside Mining Company and1954 U.S. Tax Ct. LEXIS 178">*190 Big Buck Mining Company after a period of approximately one year, and in the case of North Basin Coal Mining Company after a period of less than one year.
During the fiscal year ended August 31, 1948, petitioner's gross income from the sales of coal mined by Capparell, the Hillside Mining Company, the Big Buck Mining Company, and the North Basin Coal Mining Company was $ 1,753,244.17.
During the fiscal year ended August 31, 1948, Capparell received the aggregate amount of $ 786,869.10 from petitioner pursuant to the agreement of December 10, 1946, as amended.
22 T.C. 571">*576 During the fiscal year ended August 31, 1948, petitioner paid the following amounts to the deep mining contractors pursuant to their respective oral agreements:
| Hillside Mining Company | $ 15,236.28 |
| Big Buck Mining Company | 34,050.69 |
| North Basin Coal Mining Company | 18,924.12 |
During each of the taxable years involved neither Capparell nor any of the other independent contractors who mined coal for petitioner had an economic interest in petitioner's coal in place.
OPINION.
1954 U.S. Tax Ct. LEXIS 178">*191 The question presented involves the amount which the petitioner is entitled to deduct as percentage depletion for coal under sections 23 (m) and 114 (b) (4) of the Internal Revenue Code. The amounts involved are not in dispute. The parties are in accord that the controversy narrows to the question of whether under the facts and circumstances here presented the respective independent contractors had an economic interest in the coal mined on the properties of the petitioner.
The major payments involved herein were made under a written contract between the petitioner and the Capparell Stripping & Construction Company, Inc., the pertinent provisions of which are set forth in our Findings of Fact. Under the contract Capparell was to receive a specified amount per ton for the mining of the coal delivered to the cleaning plant owned and operated by the petitioner. The payments were to be made at stated intervals; they were not dependent upon the price the petitioner received upon the sale nor dependent on whether the petitioner sold the coal. The petitioner was required to take coal only at such times as its breaker was in operation. It was not required to run its breaker nor was it liable for damages for failure to operate it. Petitioner had the right to suspend work under the contract for an indefinite period without1954 U.S. Tax Ct. LEXIS 178">*192 liability. If the suspension continued for a period of five weeks, Capparell had only the right to elect to terminate the contract. Therefore, the amount of coal to be mined was under the control of the petitioner. If it suspended work under the contract, Capparell had no right to mine and sell coal, and it could only terminate the contract.
The petitioner also had agreements with three other independent contractors under which they were to deep mine and deliver to the petitioner coal from its properties. These agreements were oral. The evidence establishes that all three contractors were under the control of petitioner and were to be paid at a fixed price per ton for the material delivered to the petitioner. All the agreements were terminable 22 T.C. 571">*577 at will, and all agreements were terminated by the petitioner after a period of approximately one year or less.
In our opinion the evidence presented by this record amply supports our ultimate finding of fact that Capparell, under its written contract, and the independent contractors, operating under oral agreements, were not owners of an economic interest in the coal in place. Morrisdale Coal Mining Co., 19 T.C. 208.1954 U.S. Tax Ct. LEXIS 178">*193 Cf. J. E. Vincent, 19 T.C. 501, 524, reversed as to this issue sub nom Commissioner v. Gregory Run Coal Co., 212 F.2d 52.
The respondent relies upon our decision in the case of James Ruston, 19 T.C. 284, as fully supporting his determination. Cf. Helen C. Brown, 22 T.C. 58, which held under the pertinent facts that our decision in the Ruston case was controlling.
We think the facts and circumstances found to be determinative in the Ruston case are not present in the case at bar. The contractor in the Ruston case had the exclusive right to mine the coal from the premises until the seam was exhausted. The contractor was required to perform certain duties imposed upon the coal company under its leases and was required to take risks as to what the ultimate selling price would be and to receive 83 per cent of the net selling price. On the basis of such facts we held that the contractor had an economic interest in the coal in place. In the Brown case we held the contractor had the exclusive right to mine the coal from the properties and1954 U.S. Tax Ct. LEXIS 178">*194 was to be paid a percentage of the amount of gross sales after deducting royalties, siding rentals, and commissions.
In the Vincent case we held that the contracts there in question more nearly resembled those involved in the Morrisdale case rather than those involved in the Ruston case, and adopting the rationale of the Morrisdale case we held the independent contractors who were to strip mine the coal had no economic interest in the coal in place. While our decision has been reversed as to that holding, we do not regard the decision of the Court of Appeals as controlling our decision in the instant case. We think the reasons set forth herein, why our decision in the Morrisdale case is controlling here, distinguish the instant case from the controlling facts in the Vincent case.
We therefore hold that the respondent erred in reducing the petitioner's gross income from the sale of coal by the amounts paid in the taxable years in question to the independent contractors for mining its coal.
Certain other adjustments made by the respondent are not in controversy.
Decision will be entered under Rule 50.