A Mining Company
A MINING COMPANY leased rather than sold its interest in a mine to a third party, the IRS decided on audit.
The decision affects how much and when income must be reported from the transaction. It is interesting because it suggests a tax planning tool that might be used to avoid triggering a sale.
The mining company owned an interest in the mine in a joint venture with other companies, but the owners elected for US tax purposes to treat each owner as if it owned an undivided interest in the mine directly. Each reported its share of revenue and costs directly.
The mining company transferred its fractional interest in the mine to a third party. It was paid cash up front for the interest and was promised another lump-sum “bonus payment” in the future if the mineral reserves increase by at least X tons. It will also receive ongoing “production royalties” that are a percentage of revenue from sales of output, but these payments do not start until output sales from the mine pass a threshold.
The IRS addressed what label to put on the transaction in a “technical advice memorandum,” or a ruling by the national office to settle a dispute between a taxpayer and an IRS agent. The ruling is Technical Advice Memorandum 201448002. The IRS made it public in December.
The IRS said whether the transfer of an interest in a mine is a lease or a sale turns on what sort of interest, if any, the seller retains. If the owner retains no interest, then the transfer is a sale. It is also a sale if the owner transfers a non-operating interest and retains an operating interest. For example, the owner retains the right for a period of time or for a fixed tonnage to remove minerals, but transfers everything else. It is a lease if the owner retains an “economic interest.” An economic interest is a right to ongoing payments that are tied to production.
The IRS pointed to a 1972 US Tax Court decision in a case called Ridley v. Commissioner where a mine owner received an upfront payment at closing and no further payments until about 42% of the ore reserves had been extracted. Thereafter, the mine owner was paid a royalty on output. The Tax Court said no sale occurred.
The transfer in this case was a lease, the IRS said. The possible bonus payment was not an “economic interest” because it was not tied to the mine output, but the production royalty is an economic interest.
Keith Martin in Washington