Ideal Basic Indus., Inc. v. Comm'r of Internal Revenue

• Decision Date: 29 February 1984
• Docket Number: Docket No. 11847–78.
• Citation: 82 T.C. No. 28,82 T.C. 352
• Parties: IDEAL BASIC INDUSTRIES, INC., AND SUBSIDIARIES, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

82 T.C. 352

82 T.C. No. 28

IDEAL BASIC INDUSTRIES, INC., AND SUBSIDIARIES, Petitioners

v.COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 11847–78.

United States Tax Court

Filed February 29, 1984.

Potash Corporation of America (PCA), a division of petitioner, mines and concentrates sylvinite ore, producing five grades of potassium chloride or muriate of potash which it sells primarily for use as an agricultural fertilizer. The Commissioner agrees that the muriate produced by flotation constitutes mining for the purpose of computing petitioner's allowance for percentage depletion but determined that PCA's treatment processes, involving the leaching and crystallization of muriate “fines” and dust in order to produce its soluble and chemical grade muriate, are refining or manufacturing processes and, therefore, nonmining processes. Held: leaching and crystallization of muriate “fines” and dust by PCA constitute mining treatment processes within the meaning of sec. 613(c)(4), I.R.C. 1954. (Issue 1)

The Commissioner determined that PCA is not entitled to use the actual sales, or representative market or field price to compute its gross income from mining because its storage and loading for shipment of potash were nonmining processes, thus requiring use of the proportionate profits method. Held: the storage and loading for shipment performed by PCA are mining processes and PCA is entitled to use the actual sales price, or representative market or field price in computing its gross income from mining. (Issues 2, 3)

The Commissioner determined that PCA's standard muriate was not of a like kind and grade as the muriate it ships to other cities for conversion into potassium sulphate. Potassium sulphate is also a fertilizer component. The oil added to the standard muriate to prevent caking interferes with the sulphate conversion process and is omitted from the muriate used for this purpose. The oil does not enhance the value of the standard muriate as a fertilizer. In addition, a greater percentage of post-flotation amines, present in the standard muriate, are removed because they, too, interfere with the conversion process. The Commissioner denied use of the f.o.b. mine sales price of the standard grade muriate as a representative market price for the muriate shipped for conversion. Held: the muriate shipped for conversion containing no oil and slightly fewer amines is of like kind and grade as the standard grade muriate with appropriate adjustments for oil and amine cost differences. (Issue 4)

The Commissioner determined that the cost of leasing railroad cars and freight prepaid by PCA on customers' accounts for muriate transported in the leased rail cars were nonmining costs for purposes of applying the proportionate profits formula. Held: PCA is not required to use the proportionate profits method for computing its percentage depletion allowance. Reasonable expenses are not relevant to PCA's computation of percentage depletion which is based upon its f.o.b. mine sales price for domestic muriate and its f.o.b. port or vessel sales price less the cost of purchased transportation to the customer for exported muriate. (Issues 5, 6)

In computing the “50% limit” of “taxable income from the property” for the depletion deduction, the Commissioner determined that interest income could not be used to reduce the interest expense deduction. Held: PCA is entitled to reduce its interest expense deduction by interest income in computing “taxable income from the property” for purposes of the “50% limit” on the depletion deduction. Sec. 613(a), I.R.C. 1954. (Issue 7) Claude M. Maer, Jr., Howard W. Rea, Donald A. Barnes, David M. Ebel, Robert E. Benson, John C. Siegesmund, III, Dennis P. Bedell, and Robert D. Heyde, for the petitioners.^*

John D. Moats, for the respondent.

GOFFE, Judge:

The Commissioner determined deficiencies in and additions to petitioner's Federal income tax as follows:

+----------------------------------------------------+
                ¦               ¦            ¦Additions to tax       ¦
                +---------------+------------+-----------------------¦
                ¦Calendar year  ¦Deficiency  ¦under sec. 6653(a) 1  ¦
                +---------------+------------+-----------------------¦
                ¦               ¦            ¦                       ¦
                +---------------+------------+-----------------------¦
                ¦1971           ¦$414,016    ¦0                      ¦
                +---------------+------------+-----------------------¦
                ¦1972           ¦275,335     ¦0                      ¦
                +---------------+------------+-----------------------¦
                ¦1973           ¦867,424     ¦$43,371                ¦
                +---------------+------------+-----------------------¦
                ¦1974           ¦579,348     ¦28,967                 ¦
                +---------------+------------+-----------------------¦
                ¦               ¦2,136,123   ¦72,338                 ¦
                +----------------------------------------------------+
                

The deficiencies result primarily from adjustments to petitioner's deductions for percentage depletion with respect to its potash mining operations, with the exception of issue (7) which relates to petitioner's cement operations.

The issues remaining for decision are as follows: (1) whether the leaching and crystallization processes by which petitioner produces chemical grade muriate (and some soluble grade muriate in the chemical circuit) are mining processes within the meaning of section 613(c)(4)(D); (2) whether storage of petitioner's muriate products on its mine sites is a mining process or a process necessary or incidental to mining; (3) whether loading for shipment of petitioner's muriate products at its mines is a mining process or a process necessary or incidental to mining; (4) whether the standard grade muriate which petitioner sold to customers at Carlsbad and muriate which petitioner shipped from Carlsbad, New Mexico, to Dumas and Fort Worth, Texas, for conversion into potassium sulphate are minerals of like kind and grade so that petitioner's actual sales price (f.o.b. Carlsbad) of the former can be used as a representative market or field price for the latter; (5) whether petitioner's costs of leasing some rail cars from an independent leasing company for use by the railroads in transporting muriate for petitioner's customers is a general overhead expense rather than a direct mining or nonmining cost; (6) whether the freight charges which petitioner prepaid to the common carrier railroads for and on behalf of its customers to transport potash from petitioner's mines to its customers in leased cars must be disregarded in a depletion calculation because (a) they are not petitioner's costs, (b) they are incurred after the f.o.b. point of sale, (c) there are other sales that establish a representative market or field price on a first marketable product price, or (d) they qualify as purchased transportation to the customer; and (7) whether petitioner's interest income may be offset against its interest expense for purposes of calculating the net income limitation with respect to petitioner's cement depletion allowance.

The findings of fact and opinion are combined under the headings which describe the issues.

FINDINGS OF FACT AND OPINION

General

Some of the facts have been stipulated. The stipulation of facts and exhibits are incorporated herein by this reference.

Petitioner, Ideal Basic Industries, Inc. (Ideal Basic) is a corporation organized and existing under the laws of the State of Colorado. Petitioner and members of its affiliated group filed consolidated Federal income tax returns for the taxable years 1971 through 1974 with the Internal Revenue Service in Ogden, Utah. These returns were filed using the accrual method of accounting. For the sake of simplicity, we shall refer to petitioner in the singular.

Petitioner's Potash Company of America Division (PCA) is the continuation of a predecessor corporation, Potash Company of America, which petitioner acquired on December 31, 1967. PCA, previously as predecessor and currently as a division of petitioner, has been mining sylvinite ore and concentrating and producing potassium chloride or KCl, commonly called “muriate of potash” or “muriate,” near Carlsbad, New Mexico, since 1935. It has also operated a sylvinite mine and concentration plant at Saskatoon, in the province of Saskatchewan, Canada, since 1963.

Issue 1. Treatment Processes

The word “potash” is derived from the residues—pot ashes—originally obtained by evaporating, in iron pots, solutions dissolved out of or “leached” from wood ashes. Today, most potash is recovered through shaft mines from deeply buried salt beds deposited as the result of the evaporation of ancient seas dating back to early periods in the earth's geological history.

Potash denotes a chemical combination of the element potassium, an alkali metal, with one or more elements. When used in connection with fertilizers, potash refers to various salts of potassium, including chlorides, sulphates, and carbonates. Potash is also the term applied to the oxide of potassium, K 2O, which is an unstable compound not found independently in nature.

In order to use a common unit of measurement for the potassium content of the various salts of potassium used for agricultural purposes, the value of the potash product is normally expressed commercially in terms of the theoretical relative content of K2O (potassium oxide), or “K2O equivalent,” derived from the potassium content of the particular potash product, thus providing a basis for the comparison of all potash minerals.

In the case of muriate (KCl), the conversion ratio is 100 to 63.171, meaning that the potassium content of 100 pounds of KCl is the same as the potassium content of 63.171 pounds of K2O. Accordingly, chemically pure KCl is said to contain 63.171 percent equivalent K2O. The KCl content of muriate can, therefore, be determined from the equivalent K2O content by multiplying the equivalent K20 content by 1.583 (the reciprocal of .63171).

Potassium chloride occurs...