Missouri River Sand Co. v. Comm'r of Internal Revenue, Docket No. 15685–80.

• Decision Date: 07 August 1984
• Docket Number: Docket No. 15685–80.
• Citation: 83 T.C. 193,83 T.C. No. 12
• Parties: MISSOURI RIVER SAND COMPANY, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

83 T.C. 193

83 T.C. No. 12

MISSOURI RIVER SAND COMPANY, Petitioner

v.COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 15685–80.

United States Tax Court

Filed August 7, 1984.

Petitioner engaged in sand and gravel dredging at two locations on the Missouri River pursuant to nonexclusive licenses which granted no interest in the minerals in place. Held, petitioner did not have an economic interest in said deposits sufficient to entitle it to percentage depletion deductions. Commissioner v. Southwest Exploration Company, 350 U.S. 308 (1956), Oil City Sand & Gravel Co. v. Commissioner, 32 T.C. 31 (1959), and Victory Sand & Concrete, Inc. v. Commissioner. 61 T.C. 407 (1974) distinguished. Ernest M. Fleischer and Richard Monaghan, for the petitioner.

Patrick Dowling, for the respondent.

WILES, Judge:

Respondent determined deficiencies in petitioner's Federal income taxes for the fiscal years ending March 31, 1975, and March 31, 1976, in the amounts of $3,876.36 and $4,478.07, respectively. The issue for decision is whether petitioner held an economic interest in the sand deposits it dredged from the Missouri River within the meaning of section 1.611–1(b)(1), Income Tax Regs.

FINDINGS OF FACT

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

Petitioner is a corporation organized under the laws of the State of Missouri, with its principal place of business located in Columbia, Missouri, at the time its petition was filed in this case. At all relevant times, petitioner's sole shareholder was Harold E. Johnson.

Petitioner is engaged in the business of extracting sand and gravel from the Missouri River at Boonville and Rocheport Missouri.¹ The Missouri River is classified as navigable under section 10 of the Rivers and Harbors Act of 1899, 30 Stat. 1151, 33 U.S.C. sec. 403 (1982), and in the areas surrounding petitioner's operation the river is freely navigated by significant commercial river traffic. In Missouri, title to the beds of navigable rivers between their low water marks is held by the state, but the right to dredge and remove sand and gravel from the beds of navigable rivers is a public right available to all people of the state. Upon removal, sand and gravel dredged from navigable Missouri rivers becomes the private property of the person appropriating the material.

While state law determines title to the beds of navigable rivers, dredging operations must be conducted pursuant to permits issued by the Department of the Army, Corps of Engineers. During the period from 1950 to 1972, one of petitioner's two predecessors in interest² operated under a renewable permit issued by the Corps of Engineers which authorized it to dredge in the Missouri River between river miles 191 and 206 near petitioner's Boonville dock. Said permit was transferred to petitioner on June 1, 1972, and was periodically renewed throughout the years in issue. The other of petitioner's predecessor corporations operated pursuant to a Corps of Engineers permit which allowed it to dredge in several locations in the Missouri River, including the area between river miles 168 and 205 near petitioner's Rocheport dock. This permit was issued to the Columbia Sand Company which was a registered fictitious name of petitioner's sole shareholder, Harold E. Johnson, and after September 1972, became a registered fictitious name of petitioner. Throughout the years in issue, petitioner apparently operated under the continuing authority of its predecessor's permits since the Corps of Engineers never challenged petitioner's right to dredge in the vicinity of its Rocheport facility. In April 1975, the Corps of Engineers issued a permit in petitioner's name to dredge between river miles 168 and 206 in the vicinity of petitioner's Rocheport facility.

The permits issued by the Corps of Engineers prescribe the areas in which petitioner may dredge sand and gravel from the bed of the Missouri River. The permits do not convey any property rights either in real estate or materials, nor any exclusive privileges. The permits may also be suspended, modified, or revoked at any time by authority of the Secretary of the Army if it is determined that revocation is in the public interest. Petitioner has not and does not pay any royalty to the United States with respect to the permits issued by the Corps of Engineers, nor does petitioner pay any other fee or royalty to the State of Missouri with respect to its dredging operations.

During the years in issue, petitioner owned and operated one suction-type dredge boat which it used in its dredging operations at both Boonville and Rocheport. Petitioner periodically navigated its dredging equipment the,ten miles between Boonville and Rocheport in order to dredge in the vicinity of either facility depending upon the water conditions and demand for sand in each area. Generally, petitioner dredged sand at each location as needed or until its stockpiles were filled to capacity. At each site, the dredge pumped sand and gravel from the river bed, screened it to obtain material of the desired sizes, and deposited it in barges which were moved by towboats to petitioner's docks. At Rocheport, a clamshell crane moved the sand from the barges to a conveyor which ran the material behind the levee to a stockpile area. At Boonville, a clamshell crane moved sand from the barges directly to petitioner's stockpile area.

Petitioner is a commercial sand dredging operator,³ which requires that it provide sand of specific size and quality to meet the specifications established by purchasers of petitioner's products. For petitioner's primary market, the ready-mix concrete manufacturers, petitioner had to locate sand deposits which were low in lignite, an undesirable impurity which rendered many sand deposits unusable for the ready-mix concrete market. To avoid lignite, it is necessary to selectively dredge sand deposits. Sand deposits located in swifter water tend to contain less lignite, but it is not possible to consistently find lignite free sand in the same location.

The sand and gravel unloaded at petitioner's Rocheport facility was dredged from the stretch of the Missouri River extending from the facility upriver approximately three-quarters of a mile. At Boonville, petitioner primarily dredged deposits located within 200 yards upstream of its unloading facility. Because it is expensive and difficult to push loaded barges upriver, petitioner rarely, if ever, dredged deposits downstream from either facility.

The factors which are significant in determining whether a site is suitable for unloading and marketing sand include: the cost of developing a site in relation to the anticipated market for sand, access to the market via suitable roads and highways; adequate stockpile areas; lack of interference from river traffic in the dredging areas that would compromise the safety of the equipment; the distance that loaded barges must be towed from deposits to the unloading sites; the location, height, and type of river control structures; and the general topographical features of the land adjacent to the river. Based on these factors, there are no permanent sites suitable for profitable dredging operations adjacent to the deposits in which petitioner dredges in either the Rocheport or Boonville areas.⁴

On its income tax returns for fiscal years ending March 31, 1975, and March 31, 1976, petitioner claimed deductions of $9,391.35 and $10,262.02, respectively, for percentage depletion of sand and gravel. Respondent disallowed these deductions in their entirety on the ground that petitioner did not have an economic interest in the sand and gravel removed from the bed of the Missouri River during the years in issue.

OPINION

We must decide whether petitioner has an economic interest within the meaning of section 1.611–1(b)(1), Income Tax Regs., in the sand deposits it dredged from the Missouri River which would entitle it to depletion deductions in determining its taxable income during each of the years in issue.

Petitioner argues that it controlled the only land from which it was economically feasible to dredge deposits in the vicinity of its Rocheport and Boonville facilities, and that under the case law, it had economic control of, and therefore, an economic interest in, the sand and gravel adjacent to its riparian properties. Respondent maintains that petitioner's dredging, pursuant to permits issued by the Corps of Engineers which did not give the petitioner any legal rights in the deposits, is not entitled to percentage depletion because petitioner lacked an economic interest in the deposits. Furthermore, respondent maintains that petitioner's economic control argument is erroneous and misstates the test for an economic interest.

Section 611(a)⁵ provides as a deduction in computing taxable income a reasonable allowance for depletion pursuant to regulations prescribed by the Secretary. Section 613(a) and section 613(b)(6) provide, with certain exceptions not relevant herein, that in the case of sand the allowance for depletion under section 611(a) shall be five percent of the gross income from the property (as defined in section 613(c)).

Depletion deductions are allowed on the theory that mineral deposits are wasting assets and that the extraction of minerals gradually exhausts the capital investment in the mineral deposit.⁶ The deduction is 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. Commissioner v. Southwest Exploration Co., 350 U.S. 308 (1956). However, the arbitrary percentage depletion deduction allowed under section 613 bears little relationship to the taxpayer's capital investment, and the taxpayer may continue to claim percentage depletion deductions so long as minerals are extracted, even if the amount recovered exceeds the taxpayer's capital investment and no money was actually invested in...