CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE FOURTH CIRCUIT.
Warren, Black, Douglas, Clark, Harlan, Brennan, Stewart, White, Goldberg
MR. JUSTICE CLARK delivered the opinion of the Court.
The issue in these consolidated tax cases is whether the lessee*fn1 of coal lands is entitled to percentage depletion on all the gross income derived from the sale of the coal
mined from its leases, or whether contract miners who do the actual mining acquired a depletable interest within the meaning of §§ 611 and 613 (b)(4) of the Internal Revenue Code of 1954 to the extent they were paid by the lessee for mining and delivering coal to it.
The mining contractors, respondents in No. 237, claimed an allocable portion of the allowance for the years 1954 through 1956, while the lessee, petitioner in No. 134, claimed the right to the entire depletion deduction for 1955 through 1957. In each case the deduction was denied the taxpayer. However, the Commissioner now takes the position that the lessee is entitled to the entire allowance;*fn2 the Tax Court so held, 39 T. C. 257, but the Court of Appeals agreed with the contractors. 330 F.2d 161. We granted certiorari in No. 134, 379 U.S. 812, and in No. 237, 379 U.S. 886, and consolidated them for argument. We have concluded that the Tax Court was correct and reverse the judgment of the Court of Appeals.
The parties agree that the principles of our opinion in Parsons v. Smith, 359 U.S. 215 (1959), are controlling here. There we held that the deduction is allowed in recognition of the fact that mineral deposits are wasting assets and that the deduction is intended as compensation to the owner for the part used in production; that there may be more than one depletable interest in the same coal deposit, but that the right to an allocable portion of the allowance depends on the ownership of an economic interest in the coal in place since the statute makes the deduction available only to the owner of a capital interest in such deposit; and, finally, that the legal form of such capital interest is unimportant so long as it constitutes a right with regard to the coal in place.
The problem arises in applying those principles "according to the peculiar conditions in each case."*fn3 The mining contractors contend that they made a capital investment in the coal in place because of the nature and extent of their expenditures in preparation for and in the performance of oral agreements which they claim granted them the right to mine certain designated areas to exhaustion. They contend that they could only look to the extraction and sale of coal for a return of their investment, and thus that the test of Parsons v. Smith, supra, is satisfied.
Paragon, on the other hand, says that Congress never intended for contractors mining coal to have a depletable interest as evidenced by statutory enactments adopted subsequent to the tax years involved in Parsons v. Smith, supra ; that in the case of a lease the lessor of coal lands is no longer granted a deduction for depletion but is relegated to capital gains treatment only.*fn4 And, finally, that the expenditures made by the contractors were only for equipment which they depreciated and could not constitute an investment in the coal in place as required under Parsons v. Smith, supra.
The Commissioner of Internal Revenue takes the position that only a taxpayer with a legally enforceable right to share in the value of a mineral deposit has a depletable capital or economic interest in that deposit and the contract miners in this case had no such interest in the unmined coal.
Paragon took an assignment of written leases on the coal in and under certain lands which obligated it to pay annual minimum cash royalties, tonnage royalties, land taxes, and to mine all or 85% of the minable coal in the
tracts. It made substantial investments in preparation for processing and marketing the coal, including construction of a tipple, a power line, a railroad siding with four spurs and the purchase of processing equipment. It also built a road from the tipple which circled the mountain close to the outcrop line of coal. This road was used to truck the coal from the contractors' mines to Paragon's tipple.
Paragon made oral agreements with various individuals and firms to mine the coal in allocated areas under its leases. They were to mine the coal at their own expense and deliver it to Paragon's tipple at a fixed fee per ton for mining, less 2 1/2% for rejects. It was understood that this fee might vary from time to time -- and it did so -- depending somewhat on the general trend of the market price for the coal over extended periods and to some extent on labor costs. However, any changes in the fixed fee were always prospective, the contractors being notified several days in advance of any change so that they always knew the amount they would get for the mining of the coal upon delivery. After delivery to Paragon's tipple the contractor had no further control over the coal, and no responsibility for its sale or in fixing its price. The fixed fee was earned and payable upon delivery and the contractors did not even know the price at which Paragon sold.
The contractors agreed to buy power at a fixed rate per ton from Paragon's line or put in their own diesel engine generator and compressors. A certain amount per ton was also paid by the contractors for engineering services inside the mine. An engineer provided by Paragon was used to map out or show each of the contractors the particular direction his mine was to take, the locations of adjacent mines, etc. The single engineer was utilized for all of the mines to ensure that they would not run into each other and also so that no minable coal would be
rendered unrecoverable by haphazard mining methods. Periodically, the engineer would extend his projections of the mine in order to keep it within the contractor's original location.
Because of the nature of the coal deposits, it was necessary to use the drift-mining method*fn5 which requires the opening of two parallel tunnels, one for ventilation and the other for working space and removal of coal. In this type operation the roof is supported by leaving pillars of coal in place and erecting wooden supports about every 18 inches.*fn6 However, as the miners withdraw from a mine where the coal seam has been exhausted, they take out the wooden supports and also remove the coal pillars, thus recovering the last bit of minable coal. Because of the method used it often takes six to eight weeks to develop a mine to the point where it can be operated profitably.
The nature of the coal deposits here involved was such that the miners often encountered "a sandstone roll" which is an outcrop of rock which "squeezes" out the coal. When one of these situations is encountered the miners must move large amounts of rock to reach the coal seam. During this period, of course, they are receiving no money because they are not delivering merchantable coal to Paragon's tipple.*fn7 At other times, water might accumulate which would have to be pumped out before work
could resume. Again, the contract miners received nothing for this clearing operation.
After the coal was removed it was placed in the contractor's bins at the entrance to the mine and was later trucked over a connecting roadway built by the contractor to the adjacent road of Paragon and then taken to the latter's tipple. Paragon took all of the merchantable coal mined. If its facilities were full at the moment the contractor would fill his own bins and then shut down his mine. The record shows no deliveries by the contractors to anyone other than Paragon.
Although there was nothing said at the time of the oral contracts regarding who was to receive the depletion, the Tax Court found that Paragon expected to receive that deduction and had fixed its per-ton fee for mining with this in mind. The contracts were also silent regarding termination and were apparently for an indefinite period. However, numerous contractors quit mining, and some sold their equipment, buildings, tracks, etc., to others. Under the agreements, those ceasing to operate could not remove the buildings, but could remove all other equipment. It was anticipated that the contractors would continue mining in their allocated areas as long as it was profitable and so long as proper mining methods were used and the coal met Paragon's standards. However, the contractors were under no obligation to mine any specific amount of coal and were not specifically given the right to mine any particular area to exhaustion.
The contractors paid nothing for the privilege of mining the coal; they acquired no title to the coal either in place or after it was mined; they paid none of the royalty or land taxes required by Paragon's leases; they claim no sublease, no co-adventure, no partnership. Their sole claim to any interest in the coal in place is based on their investment in ...