The opinion of the court was delivered by: TROUTMAN
Plaintiff is seeking, pursuant to 28 U.S.C. § 1346(a), to recover $1,550,000.00 in federal income taxes. The facts are not in dispute. Plaintiff is engaged in the business of mining calcium carbonates from property it owns and using said materials in the manufacture of Portland cements. On December 31, 1963, plaintiff conveyed to BMAL Corporation (BMAL) three separate Calcium Carbonate Production Payments (the Payments) for the amounts of $1,000,000.00, $1,200,000.00 and $900,000.00, respectively, and BMAL in turn paid plaintiff a sum of $3,100,000.00. BMAL thus acquired the right to receive a portion of the proceeds of the mining of calcium carbonates from specific properties. In particular, the first Payment was payable out of 90% of the proceeds from calcium carbonates mined in Alsen, New York; the second Payment was payable out of 90% of the proceeds from calcium carbonates mined in Bunnell, Florida; and the third Payment was payable out of 90% of the proceeds from calcium carbonates mined in Miami, Florida. BMAL and the plaintiff further agreed that if the mining or manufacturing activities at any of the properties ceased for one year, the Payment dependent on said operations would be terminated and its primary amount added pro rata to the amount outstanding on the remaining payments.
Plaintiff treated the cash payments it received from BMAL as ordinary income of $3,100,000.00 for tax year 1963, and excluded as income in tax year 1964 the approximately $3,100,000.00 used to discharge the Payments. In so doing, plaintiff assumed that an economic interest in specific unmined calcium carbonates had been conveyed to BMAL, which, if true, would render the $3,100,000.00 paid by BMAL to plaintiff ordinary income to plaintiff in 1963 and the approximately $3,100,000.00 attributable to the actual production of the mineral income to BMAL in 1964.
The Internal Revenue Service District Director (the Director) disagreed, holding that the money paid by BMAL to plaintiff in 1963 was a loan and that no economic interest had been conveyed to BMAL. As a result, the money attributable to production of the mineral was ruled to be income to plaintiff in 1964. The Director therefore assessed BMAL for increased tax in 1964 totaling $1,550,000.00, less a 1963 refund of $759,318.63. Plaintiff paid the balance due and filed a refund claim with the Director. The Director took no action on the claim, and pursuant to 28 U.S.C. § 1346(a) plaintiff commenced this action.
The test to determine who possesses an economic interest, and is thus taxable on mineral production subject to depletion allowances set forth in the Internal Revenue Code of 1954
(the Code), is set forth in Palmer v. Bender, 287 U.S. 551, 557, 77 L. Ed. 489, 53 S. Ct. 225:
"* * * The language of the statute is broad enough to provide, at least, for every case in which the taxpayer has acquired, by investment, any interest in the * * * (mineral) in place, and secures, by any form of legal relationship, income derived from the extraction of the * * * (mineral), to which he must look for a return of his capital."
It was further held in Anderson v. Helvering, 310 U.S. 404, 408, 60 S. Ct. 952, 84 L. Ed. 1277 (1940):
"The sole owner and operator of * * * (mineral) properties clearly has a capital investment in the * * * (mineral) in place, if anyone has, and so is taxable on the gross proceeds of production and is granted a deduction from gross income as compensation for the consumption of his capital. * * * By an outright sale of his interest for cash, such an owner converts the form of his capital investment, severs his connection with the production of * * * (the mineral) and the income derived from the production, and thus renders inapplicable to his situation the reasons for the depletion allowance. * * *"
A taxpayer who makes such a transfer, in addition to severing his interest in the mineral production, converts future income into present income and thus realizes ordinary income at the time of the conveyance. Commissioner Internal Revenue v. P.G. Lake, Inc., 356 U.S. 260, 2 L. Ed. 2d 743, 78 S. Ct. 691 (1958).
In the instant case, it is clear that BMAL had an interest in the extraction of calcium carbonates, in accord with the first provision of the Palmer test. The disagreement is whether BMAL could look only to the burdened property, in accord with the second Palmer provision. Defendant argues that BMAL's ability to look to any two of the properties for pro rata satisfaction of the balance of the Payment related to the third property, if activity ceased on the third property, provided BMAL with an alternate source of satisfaction for all three investments, and thus all three Payments were invalidated as transfers of economic interests.
Plaintiff contests this assertion for two reasons. First, it argues that BMAL's contingent right to look to any two properties for income if the third failed was a contingency that was never realized. It is undisputed that production at all three sites continued uninterrupted until BMAL received the payments to which it looked for a return of its capital. Also, it argues that there is no real alternate source of satisfaction in this case because BMAL could look only to minerals from mineral-producing lands, regardless of what contingency occurred.
There are many cases in which contingencies providing for alternate sources of satisfaction never occurred, but the alternate sources invalidated the production payments as transfers of economic interests. In Christie v. United States, 436 F.2d 1216 (5th Cir. 1971) the assignee of the production payment could look to the sale of salvage equipment to recoup his investment. It was argued that at the time of the transfer it was well known that this contingency would almost certainly never occur. Nonetheless, the Court held that the transferor retained, and did not convey, an economic interest. In Commissioner v. Estate of Donnell, 417 F.2d 106 (5th Cir. 1969), the purchaser of a production payment received a personal guarantee from another party that he would purchase the unliquidated balance of the production payment. Such a purchase was never requested. However, the Court held that the purchaser did not have an economic interest. And in Anderson v. Helvering, supra, the holder of a production payment also had the right to proceeds from sale of fee title to any or all land conveyed. The record did not indicate how much of the income was from oil and gas production and "what portion, if any, was derived from sales of fees", Id., at 406, n.3. Without any proof that the contingency had occurred, the Court held that the right of the production payment holder to look to ...