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March 26, 1957

George HUSS
Francis R. SMITH, Collector of Internal Revenue, First District of Pennsylvania. Russell HUSS v. Francis R. SMITH, Collector of Internal Revenue, First District ofPennsylvania. Wesley HUSS v. Francis R. SMITH, Collector of Internal Revenue, First District of Pennsylvania

The opinion of the court was delivered by: DUSEN

The trial judge makes the following findings of fact and conclusions of law:

I. Findings of Fact

 1. Plaintiffs, George Huss, Wesley Huss and Russell Huss, during the years 1944 to 1947, were members of a partnership engaged in the business of mining coal by the strip mining method, with a principal place of business at Ringtown, Schuylkill County, Pa.

 2. Pursuant to written agreements with the Philadelphia and Reading Coal & Iron Co. (hereinafter called 'Reading'), denominated P-22, P-22B, P-29, P-32 and P-35, dated, respectively, May 27, 1944, February 23, 1945, May 8, 1945, December 17, 1945, and July 19, 1946 (plaintiffs' Exhibit 1 and Stipulation Exhibits A, B, D, & E), the plaintiffs, in the tax years 1944 to 1947, inclusive, strip mined coal on land owned by Reading in the Good Springs area known as the Tower City Tract, located in Schuylkill County, Pa.

 3. Plaintiffs also entered into another strip mining contract with Reading, P-30, dated July 16, 1945, in the Minersville area, about 10 or 12 miles from the Tower City area (Exhibit C; N.T. 86, 87).

 4. Further, plaintiffs had periodic oral strip mining arrangements with the Stevens Company (hereinafter called 'Stevens') for about four or five different tracts during the years 1944 to 1947, inclusive). *fn1"

 5. During these same years, plaintiffs also strip mined for the Jones Coal Company, Jack Jones, and the Peters Creek Coal Company.

 6. Defendant Francis R. Smith was Collector of Internal Revenue for the First District of Pennsylvania from May 1, 1945, to November 11, 1952 (Stip. par. 1). All the federal income taxes paid by plaintiffs for the tax years 1945 to 1947, inclusive, were paid to the abovestated defendant.

 Plaintiffs paid most of their federal income taxes for 1944 to the predecessor in office of the defendant Collector, but in 1946 plaintiffs each paid defendant Collector $ 987.56 as an additional payment on their 1944 income taxes. Plaintiffs' total payments of income taxes for the year 1944 are in amounts as large as the amounts they seek to recover (Stip. par. 4).

 7. The partnership of which plaintiffs are members duly filed its income tax returns for the years 1944, 1945, 1946, and 1947, but in each of said returns of its income it failed to take credit for depletion in connection with the mining contracts aforesaid, and stated the distribution to the individual partners accordingly, with the result that the distributive income of each partner was, by said return, shown to be higher for income tax purposes than it would have been had the statutory percentage depletion been deducted in such statement and return.

 8. Plaintiffs, in the years 1948 to 1950, inclusive, each filed claims for refund for the taxable periods of 1944 to 1947, inclusive. On these claims, the defendant Collector of Internal Revenue allowed plaintiffs percentage depletion only as to the Jones Coal Company, Jack Jones and the Peters Creek Coal Company, making refunds of a portion of the amounts claimed for those years. To the extent that the claims for refund were not allowed, plaintiffs were denied percentage depletion with respect to the Reading and Stevens contracts mentioned in paragraphs 2, 3, and 4 above. Statutory notices of such disallowance were sent to each of plaintiffs by registered mail on May 10, 1951 (N.T. 104 and Stip. par. 3).

 9. Plaintiff George Huss claimed refunds of $ 9,861.54 for 1944, $ 7,189.38 for 1945, $ 5,728.46 for 1946, and $ 5,107.20 for 1947.

 Plaintiff Russell Huss claimed refunds of $ 9,861.54 for 1944, $ 7,270.10 for 1945, $ 5,720.04 for 1946, and $ 5,089.91 for 1947.

 Plaintiff Wesley Huss claimed refunds of $ 9,861.54 for 1944, $ 7,270.10 for 1945, $ 5,734.30 for 1946, and $ 5,146.92 for 1947.

 The claims for refund of each plaintiff were allowed to the extent of $ 4,799.65, plus interest, for the year 1944; $ 1,847.57, plus interest, for the year 1945; and $ 646.54, plus interest, for the year 1947 (Stip. pars. 2 & 3).

 10. Prior to signing the contract of May 27, 1944, (P-22) between plaintiffs and Reading, plaintiffs went onto the land, looked over the ground, and moved in equipment so as to test for the presence of sufficient coal to start the operation.

 11. Before the five Tower City stripping contracts (see Finding No. 2) were let, Reading furnished plaintiffs with surface maps showing where the veins of coal were or where they were supposed to be. All of the tracts had been deepmined and the tract covered by P-22B had been partially strip mined, but plaintiffs were the first to strip mine on the other four areas involved in the Reading contracts.

 12. After P-22 was negotiated, plaintiffs never investigated by test boring or prospecting for coal before signing the other contracts. Plaintiffs could see where the land had been previously mined and the thickness of the exposed veins of coal. When the contracts after P-22 were offered to plaintiffs, they were well acquainted with the tracts being offered and were able to discuss prices for delivery of the coal to the colliery. Except for changes in price due to increased labor costs, plaintiffs entered into all the contracts after P-22 without detailed negotiations of their terms.

 13. Plaintiffs' job, in both the Reading and the Stevens contracts, consisted of removing the loose overburden from the top, drilling and shooting the rock overburden, removing this overburden by dragline, cleaning the coal, loading the coal on trucks, and delivering it to the Westwood colliery operated by Stevens. When the coal was delivered to the colliery, it was weighed in and, at the end of each day, plaintiffs got a sheet with the number of loads and the weight of the coal they had delivered.

 14. Reading had the right to send inspectors on the property to direct plaintiffs as to the average amount of overburden to be removed in ratio to the coal, and they occasionally exercised that right. The inspector also checked the coal to see whether it was acceptable or not before it was loaded in trucks.

 15 The coal from the Forestville area was delivered to the same colliery by railroad cars on the Reading Railroad. Plaintiffs' contract, P-30, called for loading the coal at a siding in Forestville, and, pursuant to a working agreement between Reading and Stevens, one of the latter two paid the freight from the loading point to the colliery.

 16. In all of the Reading contracts, plaintiffs were paid a stated price per ton of coal delivered to the colliery (N.T. 33, 35, Article 37 of P-22). *fn2"

 17. As to both the Reading and Stevens contracts, plaintiffs themselves determined when and where to begin and to stop the mining in a particular area. They also determined whether or not it would be profitable to begin strip mining. If plaintiffs had determined that it would not have been economically possible, they were not entitled to be reimbursed for their prospecting costs.

 18. Plaintiffs paid the men who did the work in this operation and also paid for all of the equipment, supplies and materials.

 19. In order to get the equipment to the first job site, plaintiffs spent $ 10,000 to $ 15,000 for building roads and moving. This figure, though, includes plaintiffs' labor and supply costs -- i.e., the cost of their own employees. One shovel was moved 1 1/2 miles and the other 3 1/2 miles to this first Tower City tract. Both were moved by walking them on their own power. The other Tower City stripping areas were contiguous areas, adjacent to one another, and, except for some equipment purchased to put on those tracts, plaintiffs moved equipment from one tract to another. No equipment was permanently affixed to any of the tracts so as not to be feasibly removed. But none of the equipment could very well be used for purposes other than coal stripping except the bulldozers and trucks.

 20. After the stripping of the Forestville tract, the equipment used there was moved to Tower City and, at the end of 19478 plaintiffs' equipment was either moved onto other properties or sold.

 21. The equipment initially taken in for the first Tower City contract job in 1944, and not acquired solely for that contract, included two draglines (one 2 1/2-yard and one 3 1/2-yard dragline), bulldozers, drills, air compressors, a number of trucks, and about 15 large trucks and coal haulage trucks, the value of all of which was 'around $ 100,000.' Other materials used in carrying out the strip mining contracts were all sorts of parts and supplies, cables, fuel oil, motor oil, greases, gasolines, electricity, and parts for machinery. Also, plaintiffs had to construct buildings, shops and supply houses. *fn3" During the operations on the Tower City contracts, one 2-yard dragline was shifted to another operation. By the end of 1947, plaintiffs had 'around $ 500,000. worth of equipment' on the job. But this same equipment had been used on other coal stripping contracts not with Reading, with the exception of the 3 1/2-yard machine.

 22. All of the equipment and supplies used in the contracts with Reading and Stevens were paid for by plaintiffs, but plaintiffs took deductions on their tax returns for all those items -- i.e., the labor force and the equipment -- as ordinary and necessary expenses of doing business. Also, plaintiffs got depreciation on the described equipment.

 23. About three weeks after entering onto P-22, plaintiffs were producing a small amount of tonnage, but it was at least two months before they got tonnage that would compensate them and give them a small profit. 'Some coal' was produced off P-29 shortly after that contract was signed.

 24. The Reading contracts required plaintiffs to strip mine coal as long as no more than a specified ratio of cubic yards of overburden per gross ton of raw coal recovered was present (N.T. 137-8, Article 2 of P-22). When the ratio, usually four or six cubic yards of overburden to one ton of coal, ran higher than that specified in the contracts, it would usually be unprofitable to strip mine coal, and plaintiffs were not required to do so. Plaintiffs could continue to strip mine at ratios higher than that specified in the contract if they thought the price warranted their so doing. *fn4"

 25. The contract price arrived at in the Reading contracts was arrived at after considering, among other things, the amount of overburden that was to be removed to obtain one ton of coal, the possibility of recoverable coal in the tract, and the length of the haul from the tract to the point of delivery. *fn5"

 26. The negotiations between plaintiffs and Reading for the price of the work to be performed were originally conducted on behalf of Reading by the company's engineer in charge of coal stripping in the ara. In determining whether to recommend acceptance of the price to the company, the company engineer had available an economic study prepared by another department of the company, which appraised the future market price of coal. His recommendation to Reading was based upon the fixed costs, his estimate, or the estimate furnished to him, of the future market price of coal, and a figure designed to insure a reasonable margin of profit.

 27. The contracts provided for an increase or decrease in the price per ton of coal corresponding to a change in labor costs *fn6" (Article 38 of P-22, N.T. 38).

 28. Except when labor prices changed, plaintiffs were paid the same price per ton of coal delivered whether or not Reading sold it or whatever price Reading obtained on the market. If Reading could not sell the coal or the market price fell, Reading still had to pay plaintiffs the contract price unless they closed the job down (N.T. 103, 109, 110, 156-7; see paragraph 30 below). There was no change in the contract price because of a change in the market.

 29. The coal did not belong to plaintiffs. If Reading rejected the delivered coal, plaintiffs had no right to sell the coal without Reading's agreement. If Reading agreed, then plaintiffs could negotiate the sale of the coal to another colliery. Reading would then collect the purchase price from the buyer and pay plaintiffs the contract price per ton.

 30. Reading, in its discretion, could entirely cancel and terminate the contracts prior to the completion of the stripping by giving thirty days' written notice to plaintiffs of its intention to do so (Article 23 in all of the Reading contracts). *fn7"

  31. No particular duration of time was specified in the agreements with Reading or Stevens and plaintiffs continued to strip mine under the contracts until they reached the stipulated ratios embodied in the contracts and it was no longer profitable to continue stripping. Plaintiffs then had completed their contracts and such contracts were cancelled by mutual agreement. Neither Reading nor Stevens ever unilaterally terminated or suspended operations on any of the contracts.

 32. The four or five tracts concerning which the Stevens agreements were made also are in the Good Springs area. In 1944, Stevens had an operating agreement with the owners of the land, the County Commissioners of Schuylkill County, paying them for the right to extract from the land any coal that they located. On or before December 31, 1944, *fn8" Western Anthracite (whose office is at Pottsville) contracted with the County Commissioners and got control of this land.

 33. On or before December 31, 1944, plaintiff Russell Huss made an oral agreement for plaintiffs with Anthony Mosseline, of Western Anthracite (hereinafter called 'Western'), permitting plaintiffs to go on the land and prospect for coal in return for a stated royalty per ton. If plaintiffs found and uncovered coal, Western could never refuse to let plaintiffs take such coal off the land and sell the coal to whomever they wanted, providing they would pay Western all of their royalties. Thus, as soon as plaintiffs uncovered a vein of coal, a binding obligation was in force between them and Western.

 34. There was also a working agreement between plaintiffs and Stevens *fn9" whereby plaintiffs, having the privilege of going on the land from Western, would find a vein of coal and show a sample of it to Joseph Jones of Stevens. A price would then be negotiated between plaintiffs and Stevens. Plaintiffs would deliver the coal to the Westwood colliery and Stevens would pay plaintiffs the agreed upon price and also pay Western the royalty obligation that plaintiffs had to the latter. *fn10"

 35. These individual agreements between plaintiffs and Stevens for the coal from the particular vein contemplated a stated price per ton delivered to the colliery. The stated price per ton was determined after considering such factors as the market value of the coal at the time of the agreement, *fn11" the quality of the coal, and the length of the haul to the colliery. This agreed upon price was subject to renegotiation at any time.

 369 Plaintiffs were not obligated to sell and Stevens was not obligated to buy. At any time Stevens could stop taking coal at the agreed price. If Stevens refused to take the coal, plaintiffs had the right to sell it on the open market. But plaintiffs always sold their coal taken from Western lands to Stevens.

 37. Paragraphs 7 (first sentence only, substituting the word 'these' for the word 'all' and deleting the words 'but not limited to' and 'quality'), 8, *fn12" 9 (amended to specify that the testimony did not make clear whether the Reading or Stevens contracts or both were involved) and 10 requested by plaintiffs are correct but are found by the court to be of slight or no relevancy.

 All plaintiffs' requests for findings of fact which are inconsistent with the foregoing are denied.

 II. Discussion

 Treasury Regulation 111, § 29.23(m)-1, promulgated under the Internal Revenue Code of 1939, outlines the following standard in determining who is entitled to take the percentage depletion deduction for strip mining coal under §§ 23(m) and 114(b) of the Internal Revenue Code of 1939, 26 U.S.C.A. § 23(m) and 114(b)(4):

 'The owner of an economic interest in mineral deposits or standing timber is allowed annual depletion deductions * * * An economic interest is possessed in every case in which the taxpayer has acquired, by investment, any interest in minerals in place or standing timber and secures, by any form of legal relationship, income derived from the severance and sale of the mineral or timber, to which he must look for a return of his capital.' *fn13"

 The Supreme Court has stated in Burton-Sutton Oil Co. v. Commissioner of Int. Rev., 1946, 328 U.S. 25, 34-35, 66 S. Ct. 861, 867, 90 L. Ed. 1062, an oil depletion case, that 'It is the lessor's, lessee's or transferee's 'possibility of profit' from the use of his rights over production, 'dependent solely upon the extraction and sale of the oil,' which marks an economic interest in the oil * * *' not the title to the mineral in place. 'As the oil is extracted and sold that economic interest in the oil in place is reduced and the holder or owner of the interest is entitled to his equitable proportion of the depletion as rent or royalty.'

 The Court of Appeals for the Third Circuit has recently considered this problem in Commissioner of Internal Revenue v. Mammoth Coal Co., 3 Cir., 1955, 229 F.2d 535, 537, rehearing denied, 3 Cir., 1956, 229 F.2d 539, and noted that 'there is no general rule that a strip miner is or is not entitled to percentage depletion.' What constitutes an economic interest will be determined by 'the facts in each case.'

 Plaintiffs are not entitled to percentage depletion on amounts received under the Reading contracts based on these principles for the following reasons:

 A. The right of plaintiff to strip mine was terminable on thirty days' notice at the will of the owner of the coal lands.

 Under the agreement in the Mammoth case, supra, the court said 229 F.2d at page 538:

 'The stripper had the exclusive right to mine coal in the areas embraced by the agreement. This exclusive right was not limited in time but was to continue indefinitely. The (Coal Co.) did have the right to call for a suspension of mining operations, and in such event under certain conditions regarding time and notice the stripper was free to give up the mining operation, but this was his own choice and unless he voluntarily did so, the (Coal Co.), though calling for a suspension of operations, could not permit anyone else to mine the area. Thus, for all practical purposes, the stripper had the exclusive right to mine the area to exhaustion.'

 On rehearing to consider the coal company's contention in the Mammoth Coal Co. case that 'the contractor's rights were at all times terminable by the (Coal Co.),' the court found this not to be true, *fn14" and stated, 229 F.2d at page 539:

 '* * * Usibelli v. Commissioner of Internal Revenue, 9 Cir., 229 F.2d 539, relied on by the taxpayer, is in complete accord with the disposition which we made in the opinion filed by the Court in this case on November 30, 1955. In Usibelli the Court pointed out that the contract there was terminable at the will of the taxpayer mine owner.' *fn15"

 In the Reading contracts in this case, while it appears that the stripper had an exclusive right to mine coal in the areas embraced by the agreements, *fn16" such right was not to continue indefinitely. Plaintiffs have failed to sustain their burden in proving an oral variation of the terms of Article 23 (the Suspension of Work clause) in the written contracts *fn17" and at any time, with proper notice, Reading had the right to entirely cancel and terminate the contracts.

 B. Plaintiffs had a right to receive a fixed price per ton, irrespective of the market price.

 In the Mammoth case, 229 F.2d at page 538, the court said:

 'Although all extracted material was to be delivered to the (Coal Co.), the (Coal Co.) specifically reserved the right to reject any and all coal or coal material delivered to it, and thereupon the stripper would be free to sell the rejected coal to anyone it pleased for its own account.'

 The Third Circuit Court, in awarding percentage depletion deduction to the stripper, reasoned that when the stripper removed coal from the ground, 'the (Coal Co.) was entitled to receive it. But the (Coal Co.) was not obligated to take it. If it chose not to, it owed the stripper nothing, and the stripper would be free to sell the coal to any one at whatever price it could get.'

 With these factors in mind, the court concluded, also on page 538 of 229 F.2d that:

 'The fact that, instead of retaining coal, the stripper received so much per ton for that coal which first had to be offered to and accepted by the (Coal Co.) should make no difference, for in any event the stripper had to look to the coal which it mined for return of its investment and profit.'

 On the other hand, the situation presented in the Reading contracts is one where plaintiffs were always required to sell the strip mined coal to Reading in return for a stated price per ton delivered to the colliery, such price being adjustable If Reading rejected the coal, plaintiffs decrease in plaintiffs' labor costs, but not any changes in the market price. If Reading rejected the coal, plaintiffs needed Reading's agreement to sell the coal to another colliery, and even then Reading collected the purchase price from the buyer and paid to plaintiffs the standard contract price per ton.

 C. The coal remained an asset of Reading, rather than of plaintiffs.

 The basic theory involved is 'that the deduction be allowed to the owner of wasting assets as compensation for that part of his assets which are used up in production.' Usibelli v. Commissioner of Internal Revenue, 9 Cir., 1955, 229 F.2d 539, 542. *fn18" In Kirby Petroleum Co. v. Commissioner, 1946, 326 U.S. 599, 603, 66 S. Ct. 409, 411, 90 L. Ed. 343, the court stated the rule as follows:

 'The test of the right to depletion is whether the taxpayer has a capital investment in the oil in place which is necessarily reduced as the oil is extracted. See Anderson v. Helvering, 310 U.S. 404, 407, 60 S. Ct. 952, 954, 84 L. Ed. 1277.'

 Also, in Commissioner of Internal Revenue v. Southwest Expl. Co., 1956, 350 U.S. 308, 312, 76 S. Ct. 395, 398, 100 L. Ed. 347, depletion was found to be 'designed to permit a recoupment of the owner's capital investment in the minerals so that when the minerals are exhausted, the owner's capital is unimpaired.' *fn19"

  While the test for determining the presence of an economic interest in the mineral in place is not governed by ownership of the land, it is apparent that plaintiffs have not shown that they looked to the severance and sale of the mineral on the open market for their compensation. Instead, it appears that plaintiffs' compensation was directly dependent upon their personal covenants with Reading. The latter did not entitle plaintiffs to a depletion allowance. They, therefore, are not entitled to share in the benefits of a statute which was designed to give compensation to persons interested in the depletion of a wasting asset.

 In conclusion, the Reading contracts contemplated: (a) the ability of Reading to terminate the contract at will upon thirty days' notice; (b) a stated price due plaintiffs notwithstanding any fluctuation in the market price; (c) plaintiffs' inability to sell the coal to another colliery on their own initiative; and (d) plaintiffs' not obtaining any separate interest in the coal itself other than that stated in the contractual arrangements.

 These factors give the plaintiffs an economic advantage, rather than an economic interest, in the coal in place, and do not entitle them to a percentage depletion deduction. *fn20"

  The oral agreements comprising the 'Stevens contracts,' though, are factually very different from the Reading contracts. Subject to plaintiffs' paying royalties to Western, once they found and uncovered coal, they could remove the coal and sell it to anyone. By the contracts with Stevens, the coal was delivered to the Westwood colliery in return for a stated price per ton, but Stevens was not obligated to buy nor were plaintiffs obligated to sell. At any time plaintiffs or Stevens could have discontinued the arrangement and plaintiffs' investments would have been subject to the price of coal on the open market. Further, plaintiffs alone could at any time have stopped strip mining if it was not, in their opinions, profitable to continue.

 While plaintiffs, in both the Reading and Stevens contracts, continued to strip mine until no longer profitable and then mutually agreed with the coal company to cancel the contract, only in the Stevens arrangements did they have the undisputed right to continue strip mining after coal had been uncovered. As distinguishable from the Reading contracts, in the Stevens arrangements the stripper, instead of looking merely to a contractual arrangement, had to look to the coal which it mined for return of its investment and profit. *fn21"

 Although it is a close case, the economic interest which the strippers acquired in the Stevens contracts was sufficiently significant to entitle them to percentage depletion.

 III. Conclusions of Law

 1. This court has jurisdiction over the parties and the subject matter.

 2. Plaintiffs, in strip mining under P-22, P-22B, P-29, P-30, P-32 and P-35 for the Philadelphia & Reading Coal & Iron Co., in the tax years 1944 to 1947, inclusive, did not acquire an economic interest in the coal in place, entitling them to the depletion allowance on their gross income derived therefrom, pursuant to Sections 23(m) and 114(b) of the Internal Revenue Code of 1939.

 3. Plaintiffs, in strip mining under oral contracts with the Stevens Company in the tax years 1945 to 1947, inclusive, did acquire an economic interest in the coal in place, entitling them to the depletion allowance on their gross income derived therefrom, pursuant to Sections 23(m) and 114(b) of the Internal Revenue Code of 1939.

 4. Plaintiffs have not sustained their burden to prove any definite arrangement of the type outlined in Findings of Fact Nos. 32 to 36 with Stevens or Western for strip mining coal prior to December 31, 1944, *fn22" and, hence, are not entitled to the depletion allowance under Sections 23(m) and 114(b) of the Internal Revenue Code of 1939 on their 1944 gross income from the Stevens contracts.

 5. Plaintiffs' motion filed January 11, 1957, for leave to amend the caption of the complaint to include the United States of America as a party defendant has become moot in view of Findings of Fact Nos. 32 and 33 and Conclusion of Law No. 4. *fn23"

  6. 33 P.S. § 1 has no application to the Stevens contracts. *fn24"

 The parties shall, within thirty (30) days of the date of the filing of these Findings of Fact and Conclusion of Law, submit their determination as to the amount of refund due plaintiffs in conformance with the above opinion.

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