*175 Decisions will be entered under Rule 50.
Petitioner contracted to go on the coal lands owned by the National Steel Corporation and to strip mine, clean, and deliver to National such coal as National might direct. Under the contract petitioner was to be paid a specified amount for each ton of coal delivered. By giving 90 days' notice either party could terminate this contract. Held, petitioner did not possess an "economic interest" in the coal in place and, therefore, was not entitled to a percentage depletion deduction under sections 23(m) and 114(b) (4) of the Internal Revenue Code of 1939. Morrisdale Coal Mining Co., 19 T. C. 208, and Mammoth Coal Co., 22 T. C. 571, followed.
*374 Respondent determined deficiencies in the income tax of petitioner and an addition to tax, as follows:
| Sec. 291 (a) | ||
| Year | Deficiency | addition to |
| tax | ||
| 1946 | $ 16,594.01 | |
| 1947 | 16,265.58 | |
| 1948 | 24,347.67 | |
| 1949 | 22,089.98 | $ 25,537.18 |
The proceedings were consolidated*176 for hearing. The only issue for decision is whether the Commissioner correctly disallowed the deduction by petitioner of percentage depletion based upon petitioner's gross income from its strip-mining operations under its contract with the National Steel Corporation. All other issues raised by the petition have been settled by agreement of the parties.
FINDINGS OF FACT.
The stipulated facts are so found.
Petitioner is a corporation with its principal offices at Weirton, West Virginia, and filed its corporation income tax returns for the years 1946 to 1949, inclusive, with the collector of internal revenue for the district of West Virginia.
Petitioner was organized in 1927. In 1937 it began engaging in the strip mining of coal, which became its principal business activity. Prior to 1941 it mined coal exclusively on its own land and sold the coal on the open market. In 1939 it began selling coal to the Weirton Steel Company of Weirton, West Virginia, a subsidiary of the National *375 Steel Corporation (hereinafter referred to as National). During the taxable years involved petitioner was also engaged in the business of contract hauling and in the business of renting trucks*177 and construction equipment.
Prior to 1940 petitioner had purchased a number of tracts of coal land either in its own name or in the name of its president, Mike Starvaggi (sometimes referred to as Miche Starvaggi). Among the tracts purchased by petitioner for its strip-mining operations were two tracts in Hanover Township, Washington County, Pennsylvania. In 1940 National became worried that the price of coal as set by Government regulations would be high, and approached petitioner's president with the idea of making a captive mine of petitioner's property in Washington County.
On February 20, 1941, petitioner, through its president, Mike Starvaggi, who was acting as petitioner's agent pursuant to an agreement dated September 26, 1939, deeded the two tracts in Washington County to National at cost and entered into the following agreement with National:
THIS AGREEMENT
Made and entered into this 20th day of February, 1941, by and between NATIONAL STEEL CORPORATION, a Delaware corporation (hereinafter referred to as "National"), as party of the first part, and MICHE STARVAGGI of Weirton, West Virginia, an individual, (hereinafter referred to as the "Contractor"), as party of the second*178 part:
WITNESSES:
Whereas National owns two tracts of coal lands, suitable for stripping operations, situated in Hanover Township, Washington County, Pennsylvania, said tracts being described in two certain deeds from Miche Starvaggi to National, dated the 20th day of February, 1941, and expects to acquire other adjoining tracts; and
Whereas the Contractor is willing to undertake to mine and remove quantities of coal for the use of National from the tracts acquired and to be acquired, to grade and clean such coal and to transport the same to National's steel plants at Weirton, West Virginia;
Now, Therefore, in consideration of the premises and of the mutual covenants and agreements hereinafter set forth, the respective parties hereto, each intending to be bound hereby, agree as follows:
1. The Contractor will mine and remove from National's coal lands hereinbefore described such quantities of coal as National may, from time to time, direct and will deliver the same by truck to National's coal docks at Weirton, West Virginia. The coal so mined and delivered shall be properly cleaned by the Contractor and shall be of such sizes as National shall from time to time specify.
2. As consideration*179 for the services to be performed by the Contractor pursuant to this agreement, National will pay to said Contractor a sum equivalent to One Dollar and Ten Cents ($ 1.10) for each net ton of coal so mined and delivered, payments to be made on or before the 20th day of each month upon *376 the basis of the tonnage delivered by said Contractor to National's coal docks during the preceding month.
3. The Contractor, at his own cost and expense, will construct and maintain on the coal lands hereinbefore described any roads and ways which may be required for his operations, and will furnish such equipment, machinery, trucks, tools, fuel, supplies, labor and power as may be necessary to perform his obligations under this agreement. National, however, will furnish to the Contractor, at National's blast furnaces at Weirton, such rough slag as the Contractor may require for the construction and maintenance of said roads and ways.
4. National will pay, or cause to be paid, any and all taxes and other Governmental charges and assessments which may be, from time to time, lawfully levied against, or imposed upon, the coal lands and the coal removed therefrom, but National shall not be in any*180 manner liable or responsible for any taxes or other charges or assessments of whatsoever nature which may be levied against, or imposed upon, the Contractor by reason of his operations under this agreement.
* * * *
6. The Contractor will, at all times, maintain such insurance, including, without limitation, adequate workmen's compensation and public liability insurance, as may be reasonably necessary to protect National against any claims for compensation or damage arising out of the death or injury of any person, or the destruction or damage of any property, which may be caused, directly or indirectly, by the operations of the Contractor under this agreement. In addition, the Contractor agrees to indemnify National and save it harmless against any such claims and against any cost, loss, or damage in any way connected therewith.
7. The consideration specified in paragraph 2 of this agreement is computed upon the basis of an average labor cost to the Contractor, as follows:
(a) Common or semi-skilled labor -- 50 cents to 60 cents an hour.
(b) Skilled labor -- $ 1.25 an hour.
(c) Supervisory salaries -- $ 175 to $ 300 a month.
If, during the existence of this agreement, there shall*181 be any material decrease or increase in the Contractor's average labor rates, as hereinbefore set forth, the Contractor with [sic] forthwith give National written notice thereof, and thereupon the consideration specified in paragraph 2 shall be adjusted by mutual agreement to reflect such decrease or increase. If the parties are unable to agree upon the proper amount of the adjustment within thirty (30) days after such notice, this agreement shall thereupon cease and determine, without any further act of the parties.
8. This agreement shall remain in full force and effect until either National or the Contractor shall elect to terminate it by giving ninety (90) days' written notice of such election to the other party.
9. It is expressly understood and agreed that the Contractor is not, and may not represent himself as being a partner, agent or representative of National, and nothing herein contained shall be construed as authorizing or permitting the Contractor to create or incur any liability or responsibility on the part of National for any debt, engagement, default or omission of the Contractor.
Between February 20, 1941, and January 1, 1942, petitioner, acting through its *182 president or in its own name, conveyed to National at cost eight additional tracts of coal land in Hanover Township, Washington County, Pennsylvania. It was contemplated, but it was not agreed, *377 that all mining of coal on the lands conveyed would be done by petitioner pursuant to the above agreement.
Petitioner began supplying National with coal from the above lands in 1941. For the first coal delivered petitioner was paid $ 1.15 per ton. By December 1946 petitioner was receiving $ 2.29 3/4 per ton, and in 1949 petitioner was receiving $ 2.76 3/4 per ton. During the years 1946 through 1949 petitioner, operating under the above agreement, supplied 100 per cent of the steam coal used at National's plants in Weirton, West Virginia. During those years petitioner also strip mined coal on its own lands which it sold on the open market.
In order to fulfill its obligations under the above agreement petitioner built macadam roads on the lands conveyed at a cost of approximately $ 30,000. The roads were extended gradually as the extraction of coal caused the mining to be conducted further from the tipple. Petitioner furnished all equipment, machinery, trucks, tools, fuel, supplies, *183 labor, and power necessary to mine, clean, and deliver the coal to National. It maintained adequate workmen's compensation and public liability insurance. It employed on the average of 68 or 69 men in the operation. It paid a fixed sum of between 5 and 40 cents per ton of coal mined to the United Mine Workers Welfare and Retirement Fund on behalf of its miners. It provided the tipple. The entire operation was conducted by petitioner without any advice or direction from National. During the taxable years involved petitioner was never advised to cut down on the amount of coal being produced.
On December 14, 1949, National entered into an "indenture" with petitioner dated May 31, 1945, whereby National conveyed all of the above lands to petitioner, but reserved to itself the oil, gas, and coal rights. In consideration for the above conveyance petitioner promised to secure the discharge of National from its agreements that it had filed or would file with regard to restoring and reforesting or replanting the lands pursuant to Pennsylvania statutes covering open pit mining operations.
During each of the taxable years involved, the number of tons of coal mined, cleaned, and delivered*184 by petitioner to National under the contract, the gross amounts received from National therefor, the amounts allocable to the delivery of the coal from the tipple, and the cost of the equipment used in the strip-mining operation were as follows:
| Tons | Gross | Delivery | Cost of | |
| Year | delivered | receipts | charges | equipment |
| 1946 | 240,804.20 | $ 526,046.67 | $ 70,777.93 | $ 290,029.10 |
| 1947 | 315,403.25 | 761,181.64 | 96,412.04 | 519,214.10 |
| 1948 | 364,953.80 | 985,540.96 | 144,249.74 | 560,843.50 |
| 1949 | 265,847.20 | 726,561.00 | 130,811.83 | 579,343.50 |
*378 In each of the taxable years 50 per cent of petitioner's net income from the operation exceeded 5 per cent of the gross receipts less delivery charges.
Petitioner, during the years 1946 to 1949, inclusive, possessed no "economic interest" in the coal in place on the tracts of land owned by National.
OPINION.
The issue presented is whether petitioner is entitled to a percentage depletion deduction under sections 23 (m) and 114 (b) (4) of the Internal Revenue Code of 1939, 1 on the coal mined, cleaned, and delivered to National during the taxable years involved. Petitioner is entitled to the depletion deduction only if it had*185 an "economic interest" in the coal in place. Kirby Petroleum Co. v. Commissioner, 326 U.S. 599">326 U.S. 599. An "economic interest" exists in "every case in which the taxpayer has acquired, by investment, any interest in the oil [or coal] in place, and secures, by any form of legal relationship, income derived from the extraction of the oil [or coal], to which he *379 must look for a return of his capital." Palmer v. Bender, 287 U.S. 551">287 U.S. 551, 557. An "economic interest" does not require title to the asset being depleted, but it does demand the existence of some right or capital investment in the coal, oil, or other mineral in place the value of "which is necessarily reduced as the mineral is extracted." It requires that the "possibility of profit" from the use of the right be "dependent solely upon the extraction and sale" of the coal, oil, or other mineral. Burton-Sutton Oil Co. v. Commissioner, 328 U.S. 25">328 U.S. 25; Kirby Petroleum Co. v. Commissioner, supra.The cost of the investment is unimportant and it makes no difference whether the return is in the form*186 of mineral in kind or cash proceeds from the sale thereof. Burton-Sutton Oil Co. v. Commissioner, supra."But the phrase 'economic interest' is not to be taken as embracing a mere economic advantage derived from production, through a contractual relation to the owner, by one who has no capital investment in the mineral deposit." Helvering v. Bankline Oil Co., 303 U.S. 362">303 U.S. 362.
*187 Applying the above principles to the facts in the instant case, we have found that petitioner did not possess an "economic interest" in the coal in place. The payments received by petitioner were made pursuant to a written contract with National, the pertinent provisions of which are set forth in our Findings of Fact. Under the contract petitioner undertook to mine quantities of coal from tracts of land owned by National for the use of National in its steel plants, to clean and grade the coal and to transport the coal to National's steel plants at Weirton, West Virginia. Petitioner was to receive a specified price per ton of coal delivered -- the price to be increased or decreased to reflect any material increase or decrease in petitioner's labor costs. Petitioner was to provide all equipment and to pay all expenses necessary to the performance of its services. National was to pay all taxes on the lands and on the coal removed therefrom. The contract provides, "The Contractor [petitioner] will mine and remove from National's coal lands * * * such quantities of coal as National may, from time to time, direct and will deliver the same * * *." The contract could be terminated by*188 either party by giving 90 days' notice.
As a result of the above contract, petitioner enjoyed an advantageous relationship with National whereby it hoped and expected to derive a profit. Such a relationship, however, is not the equivalent of an "economic interest" in the coal in place. Unlike the facts in James Ruston, 19 T.C. 284">19 T. C. 284, 295, wherein this Court held that the strip-mining contractor had an "economic interest" in the coal, petitioner did not have the "sole and exclusive right to strip coal from the mining premises until the seam should be exhausted" and petitioner's compensation was not dependent upon the selling price of the coal. See also Helen *380 , 22 T.C. 58">22 T. C. 58. In the two cases last cited the contractor acquired an "economic interest" in the coal by obtaining the right to mine all of the coal for which he would be paid a percentage of the proceeds derived from the sale of the coal. The value of the right thus obtained was necessarily reduced by the extraction of the coal and the contractor's only "'possibility of profit' from the use of his rights over production" was "dependent solely*189 upon the extraction and sale" of the coal. Burton-Sutton Oil Co. v. Commissioner, supra.Here the petitioner could mine the coal only if directed to do so by National, and National could terminate the contract at any time on 90 days' notice. Under these circumstances petitioner did not have any rights over the production of the coal and under the contract it did not acquire any right, interest, or investment, the value of which was necessarily reduced as the coal was extracted. Furthermore, during the taxable years petitioner was being paid, not for the coal, but for its services in mining, cleaning, and delivering the coal to the owner and ultimate user. Variations in the amount of the payments depended upon changing costs and not market fluctuations. Petitioner had no right to be paid in kind and the payments were not made out of the proceeds from the sale of the coal.
Petitioner contends that the contract with National was the equivalent of a lease, citing Eastern Coal Corporation v. Yoke, 67 F. Supp. 166">67 F. Supp. 166. We disagree. The contract in question not only bears no resemblance to a lease, but it would be an*190 unusual lease that permitted the lessee to mine only such coal as the lessor directs, required the delivery to the lessor of all the coal so mined, and granted the lessor the right to terminate the lease at any time on 90 days' notice. Furthermore, unlike the Eastern Coal Corporation case, National, as the owner, paid all of the taxes on the land and on the coal.
The present situation is also entirely different from that existing in North Range Mining Co., 46 B. T. A. 296. There, the lessee of certain iron mines was required to mine and deliver to the lessor iron ore in amounts required by the lessor at a stated price per ton, but the lessee could also mine and sell to third parties as much iron ore as it wished by paying a royalty to the lessor. This latter right was held to give the lessee an "economic interest" in the entire mineral deposit. Cf. Morrisdale Coal Mining Co., 19 T. C. 208 (on appeal C. A. 3).
Petitioner stresses the fact that it entered into an indenture with National whereby the latter reconveyed the surface rights to petitioner, that it received no interference or directions from National with *191 regard to the performance of its services, that it conducted the mining operations in exactly the same manner as it did on its own lands, and that it made sizable expenditures for roads and insurance *381 and had a large investment in the equipment which was used in the performance of its services. In our opinion none of these factors gave petitioner an "economic interest" in the coal in place in the taxable years involved. During those years petitioner's prior ownership of the land, which petitioner had sold to National thereby recouping its capital investment, did not change the fact that petitioner had only such rights in the coal as are embodied in the contract. Similarly, the "indenture," executed on December 14 of the last taxable year involved, did not give petitioner any interest in the coal, for National specifically reserved all rights in the coal. Furthermore, the discretion and independence which is allowed an independent contractor in the performance of his services and the similarity between those services and the conduct of like operations on the contractor's own lands, have no bearing upon whether the contractor has an "economic interest" in the coal which *192 he is extracting for another. Also, whether a contractor has an economic interest in the coal in place does not depend upon the size of the operation, the cost of the equipment employed, or the amount of expenses incurred in getting out the coal. Cf. Mammoth Coal Co., 22 T. C. 571 (on appeal C. A. 3). Such amounts are recoverable through deductions for depreciation and business expenses and are not an investment which must be recovered through depletion. Also, as petitioner was engaged in the business of contract hauling, was engaged in strip-mining operations on its own lands, and was in the business of renting trucks and equipment, the equipment used in the performance of its services for National could undoubtedly have been profitably employed elsewhere; and the roads were extended only as mining operations grew further from the tipple.
In every material respect the facts herein are virtually on all fours with Morrisdale Coal Mining Co. and Mammoth Coal Co., both supra, wherein this Court held that the respective strip-mining contractors involved did not acquire an "economic interest" in the coal in place. On the basis of the reasoning*193 in the above two cases we have found as an ultimate fact that petitioner did not possess an "economic interest" in the coal on the lands of National. In the Mammoth Coal Co. case this Court distinguished for factual differences Gregory Run Coal Co. v. Commissioner, 212 F. 2d 52, certiorari denied 348 U.S. 828">348 U.S. 828, reversing in part J. E. Vincent, 19 T. C. 501, relied on by petitioner. We think the instant proceeding is likewise distinguishable. It follows that petitioner is not entitled to the claimed depletion deduction.
Decisions will be entered under Rule 50.
Footnotes
1. SEC. 23. DEDUCTIONS FROM GROSS INCOME.
In computing net income there shall be allowed as deductions:
* * * *
(m) Depletion. -- In the case of mines, oil and gas wells, other natural deposits, and timber, a reasonable allowance for depletion and for depreciation of improvements, according to the peculiar conditions in each case; such reasonable allowance in all cases to be made under rules and regulations to be prescribed by the Commissioner, with the approval of the Secretary. In any case in which it is ascertained as a result of operations or of development work that the recoverable units are greater or less than the prior estimate thereof, then such prior estimate (but not the basis for depletion) shall be revised and the allowance under this subsection for subsequent taxable years shall be based upon such revised estimate. In the case of leases the deductions shall be equitably apportioned between the lessor and lessee. In the case of property held by one person for life with remainder to another person, the deduction shall be computed as if the life tenant were the absolute owner of the property and shall be allowed to the life tenant. In the case of property held in trust the allowable deduction shall be apportioned between the income beneficiaries and the trustee in accordance with the pertinent provisions of the instrument creating the trust, or, in the absence of such provisions, on the basis of the trust income allocable to each.
For percentage depletion allowable under this subsection, see section 114(b), (3) and (4).
SEC. 114. BASIS FOR DEPRECIATION AND DEPLETION.
(b) Basis for Depletion. --
* * * *
(4) Percentage depletion for coal, * * *
(A) In General. -- The allowance for depletion under section 23(m) shall be, in the case of coal mines, 5 per centum * * * of the gross income from the property during the taxable year, excluding from such gross income an amount equal to any rents or royalties paid or incurred by the taxpayer in respect of the property. Such allowance shall not exceed 50 per centum of the net income of the taxpayer (computed without allowance for depletion) from the property, except that in no case shall the depletion allowance under section 23(m) be less than it would be if computed without reference to this paragraph.
(B) Definition of Gross Income From Property. -- As used in this paragraph the term "gross income from the property" means the gross income from mining. The term "mining", as used herein, shall be considered to include not merely the extraction of the ores or minerals from the ground but also the ordinary treatment processes normally applied by mine owners or operators in order to obtain the commercially marketable mineral product or products. The term "ordinary treatment processes", as used herein, shall include the following: (i) In the case of coal -- cleaning, breaking, sizing, and loading for shipment; * * *↩