Callahan Mining Corp. & Subsidiary v. Comm'r of Internal Revenue

Decision Date24 March 1969
Docket NumberDocket No. 4231–66.
Citation51 T.C. 1005
CourtU.S. Tax Court


Petitioner, as lessor, and ASARCO, as lessee, were parties to an agreement whereby ASARCO was granted the exclusive right to explore, develop, and operate certain mining property in Idaho owned by petitioner, with ASARCO to advance all necessary expenditures therefor. Initially, the net profits from the operation of the mining property were to be used to reimburse ASARCO for such expenditures and to establish and maintain a ‘working capital’ account in the amount of $500,000. During the initial period, which ended in early 1959, petitioner was to receive and did receive 50 cents per ton of ore mined. Thereafter, petitioner was to receive 50 percent of the net profits or 50 cents per ton of ore mined, whichever amount was greater. During the remainder of 1959 and throughout 1960 and 1961, the net profits were divided equally between ASARCO and petitioner. Also, during these years, ASARCO paid an annual Idaho tax measured by the total annual net profits of the mining venture. The amount of this tax was deducted as an expense in determining the ‘net profits' under the agreement. Held, that petitioner is entitled to include in its gross income and take percentage depletion on 50 percent of the net profits which it actually received, not on 50 percent of the total gross income from the property. Held, further, that petitioner is entitled to include in its gross income and take percentage depletion on one-half of the Idaho tax paid by ASARCO. Robert H. Preiskel, Richard O. Loengard, Jr., and Robert M. Rosier, for the petitioner.1

James Q. Smith, for the respondent.


Respondent determined deficiencies in the Federal income tax of petitioner as follows:

                ¦               ¦           ¦
                ¦Taxable year   ¦Amount     ¦
                ¦1959           ¦$189,595.11¦
                ¦1960           ¦80,275.16  ¦
                ¦1961           ¦120,598.96 ¦

After various concessions by the parties, the principal issue remaining for decision is the determination of the proper method for computing petitioner's ‘gross income from mining’ for purposes of percentage depletion. A subsidiary issue involves the treatment by petitioner in computing its ‘gross income from mining’ of State net profits taxes paid for the years in question.


Some of the facts have been stipulated and are found accordingly.

Callahan Mining Corp. (hereinafter referred to as petitioner) is an Arizona corporation with its principal office and place of business in New York, N.Y., at the time the petition herein was filed. Petitioner filed its consolidated income tax returns for the calendar years 1959 and 1960 and its separate income tax return for the year 19612 on an accrual basis with the district director of internal revenue, Manhattan, New York.

Petitioner's business included, among other things, the ownership, development, and operation of mining properties on its own behalf in the Rocky Mountain area of the United States and in several Canadian provinces.

During the early 1920's, petitioner acquired a number of contiguous patented and unpatented lode claims in the Coeur d'Alene District in northern Idaho (hereinafter referred to as the Galena property) and promptly embarked upon an exploration program of such property in an attempt to make it commercially productive. Substantial sums were expended during the period 1922 to 1932. Petitioner's activities during this period included sinking of the main Galena mine shaft to a depth of 800 feet, sinking an internal shaft an additional 1,000 feet to open the lower levels, and substantial underground work amounting to several thousand feet.

In 1932, petitioner's management, faced with low metal prices and limited financial resources, suspended all work on the property. During 1937, petitioner again reopened the mine, and exploration work continued until 1938. This work indicated that a program to explore the potentialities of this property would involve outlays substantially in excess of petitioner's financial capacity. As a result, the Galena mine was closed again and remained inactive through 1945.

During the period from 1922 through 1938, underground work conducted by petitioner on the Galena property amounted to more than 34,000 feet and resulted in the production of 136,149 tons of low-grade ore, which was milled on the property at a loss.

In 1946, independent engineers hired by petitioner conducted a thorough examination of the Galena property. In their report to petitioner, they indicated that considerable risk would be involved in a deep exploration program but that, in view of the recently discovered valuable deep ore bodies in the vicinity of the Galena property, such risk would be warranted for those who could afford the loss if the work were to ultimately prove unsuccessful. Since, at that time, petitioner was either unwilling or unable to incur the substantial risk and expense of a deep exploration program, it commenced discussions with several major mining companies with a view towards securing outside financing for the development of the Galena property. Following extensive negotiations, the terms of a lease with American Smelting & Refining Co. (hereinafter referred to as ASARCO) were tentatively agreed upon, under which petitioner, after a certain point in time, would receive 50 percent of the net profits. Initially such lease was to cover only the western two-thirds of the Galena property.

During the course of the negotiations with ASARCO, petitioner's representatives wrote a letter to ASARCO's representatives stating that, as they understood the proposed lease agreement, ASARCO would be entitled to depletion of 15 percent of the gross income less payments to petitioner on account of profits, while petitioner's depletion would be limited to 15 percent of those profits. Petitioner suggested that a new paragraph be added to the proposed lease agreement to the effect that, after the parties began to share the net profits on a 50–50 basis, they would apportion the depletion allowance equally between them. Such proposal, however, was rejected by ASARCO's representatives and was not included in the lease agreement as executed.

On May 31, 1946, petitioner organized Vulcan Silver-Lead Corp. (hereinafter referred to as Vulcan) under the laws of the State of Idaho to hold that portion of the Galena property to be made subject to the lease agreement with ASARCO. Thereafter, on June 22, 1946, Vulcan received some 72 mining claims from petitioner, consisting of the western two-thirds of the Galena property, in exchange for 1,500,000 shares of Vulcan stock, constituting its then entire issued and outstanding capital stock. These claims became the nucleus of the property subjected to the lease with ASARCO (hereinafter referred to as the Galena mining property). Petitioner retained direct ownership of the remaining one-third of the Galena property. Subsequently, additional claims were acquired by Vulcan and thereafter included in the lease with ASARCO. At the time of the transfer to Vulcan, petitioner's aggregate investment in the Galena mining property (including the cost of acquisition and development expenditures) approximated $1,555,475.50.

As of January 15, 1947, Vulcan entered into a lease agreement with ASARCO (hereinafter referred to as the agreement) with respect to the Galena mining property. Pursuant to the agreement, ASARCO was granted the exclusive right to explore, develop, and operate the Galena mining property for a term of 30 years with an option to renew for an additional 30 years. The relevant provisions of the agreement are as follows:

Article 3. Possession and Control of Property.

The Lessor hereby gives and grants to the Lessee the right immediately to enter upon and take over the sole and exclusive possession and control of the property * * * and during the effective term of this lease the Lessee shall remain in the sole and exclusive possession and control thereof. The Lessee is also granted the right to * * * develop, work, mine, operate, use, manage and control said property; * * * and to mine, extract and remove from said property the ores and minerals contained therein and to treat, mill, ship, sell or otherwise dispose of the same and receive the full proceeds therefrom, subject to the terms and conditions hereinafter set forth.

Article 5. Work Requirements.

A. The Lessee further agrees (a) to take immediate possession of the property, (b) to proceed promptly with preparations necessary for the exploration thereof, (c) to pay all taxes levied against the property as provided in Article 22, * * * and (e) subject to the terms and conditions hereof, to sink a shaft on the property approximately to sea level and to drift or cross-cut at about that elevation to an extent which shall be not less than a total of five thousand (5,000) feet, all in manner, method and location as determined in the sole judgment of the Lessee; and the Lessee further agrees to advance all moneys required in connection with the performance of all such agreements. Such work shall be prosecuted diligently, * * * and the Lessee shall be reimbursed therefor as provided in Article 14.

B. It is expressly stipulated and agreed, however, that the Lessee shall not be required to expend more than Six Hundred Thousand Dollars ($600,000) in and about the shaft and drifts or cross-cuts referred to in clause (e) of paragraph A of this Article, the work in connection therewith, and the necessary buildings and equipment, and further that, anything herein to the contrary notwithstanding, there shall be no obligation hereunder on...

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    ... ... inclusive, with the district director of internal" revenue, New Orleans, Louisiana ...      \xC2" ... Cf. Callahan Mining Corp. Dec. 29,505, 51 T. C. 1005 (1969); ... ...
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