Ramey v. Comm'r of Internal Revenue

• Decision Date: 04 January 1967
• Docket Number: Docket No. 5357-64.
• Citation: 47 T.C. 363
• Parties: LESTA RAMEY AND ALKA RAMEY, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

47 T.C. 363

LESTA RAMEY AND ALKA RAMEY, PETITIONERS

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket No. 5357-64.

Tax Court of the United States.

Filed January 4, 1967.

John A. Dunkel, for the petitioners.

Conley G. Wilkerson, for the respondent.

Held: The agreement between Jisco and the petitioners is not substantively different from the agreements involved in Parsons v. Smith, 359 U.S. 215 (1959), and Paragon Coal Co. v. Commissioner, 380 U.S. 624 (1965). The petitioners herein did not therefore possess an economic interest in the subject coal in place so as to allow a deduction for depletion.

FAY, Judge:

Respondent determined deficiencies in petitioners' income tax for the years 1960 and 1961 in the amounts of $2,559.47 and $865.84, respectively.

The only issue for decision is whether petitioners are entitled to deductions for percentage depletion on coal mined from a certain tract of land known as the Blood property during the calendar years 1960 and 1961.

FINDINGS OF FACT

Petitioners Lesta (hereinafter referred to as petitioner or Ramey) and Alka Ramey filed joint Federal income tax returns for the calendar years 1960 and 1961 with the district director of internal revenue, Cincinnati, Ohio. Ramey has been engaged in the business of strip- mining coal in Jackson County, Ohio, since 1946. His business was normally carried on with a crew of three, consisting of two employees and petitioner. Petitioner's activities have been restricted to the mining, usually by the strip-mining method, of what is known as No. 1 seam coal. Because of some of its characteristics, primarily its low sulfur content and high fusion point, this coal is suitable only for blast furnace use.

The Jackson Iron & Steel Co. (hereinafter referred to as Jisco), a corporation engaged in the manufacture of silvery pig iron and foundry iron, operated blast furnaces in Jackson County, Ohio. During the years in issue Jisco was the only purchaser of No. 1 seam coal in Jackson County, Ohio. Globe Iron Co., located in Jackson, Ohio, which was purchased by Inter-Lake Iron Corp. in 1956, was the only purchaser of No. 1 seam coal other than Jisco during the period from 1949 through 1958.¹ However, Globe Iron Co. had its own supplier of coal and Ramey never had sold any coal to it.

In 1949, petitioner, acting on his own behalf, approached William and Lena Blood, the owners of a tract of land in Jackson County, for the purpose of acquiring rights to the coal underlying their land. This culminated in a lease from the Bloods to petitioner dated February 10, 1949, whereunder the Bloods leased to petitioner all the ‘stone coal’ underlying their tract (at least 196 acres described by metes and bounds in the lease) with the right to enter upon the premises to prospect for coal and to ascertain whether there was coal of sufficient quantity and quality for use in the blast furnaces of Jisco, together with surface rights and all necessary rights-of-way to remove the coal, erect tipples, etc. The initial term of this lease was for 5 years if coal of sufficient quantity and quality could be found, with the privilege in the lessee to renew for an additional term of 10 years. The lessee was to mine the coal by either the drift method or the strip method and was to pay the lessor a royalty of 30 cents per ton on all coal mined and removed by the strip-mining method and 25 cents per ton for all coal mined and removed under the drift-mining method. The lease provided that the lessee should start mining operations on the premises in 1949 and continue the mining operations thereon as the market conditions would permit during the entire term of the lease, and it further provided that the lessee was to pay to the lessor a minimum royalty of $50 per year for each 40 acres, which minimum was to be applied to tonnage royalty over a certain minimum amount.

After petitioner acquired the lease on the Blood property, Jisco and petitioner agreed that petitioner would assign the lease to Jisco, and, if it developed that there was coal underlying the property, Jisco would sublease the coal to petitioner and buy coal from him. Ramey's purpose in assigning the lease to Jisco was to create a market for the coal.

Jisco was the only possible purchaser of No. 1 seam coal of which Ramey was aware. Ramey never sold any No. 1 seam coal to any other user. He knew of no other market for No. 1 seam coal. Jisco requested the aforesaid assignment-sublease arrangement in order to control the coal reserve on the Blood property. Jisco believed that by this arrangement, it could prevent Ramey from selling coal to third parties. Jisco also believed that if Ramey remained a lessee it would have been possible for him to sell coal to Globe Iron Co., Jisco's competitor. By instrument dated February 26, 1949, petitioner sold, assigned, and transferred all of his right, title, and interest in and to the Blood lease referred to above to Jisco, and Jisco assumed all the obligations under the lease and agreed to perform all the conditions thereof.

On July 29, 1949, Jisco and petitioner entered into and executed an agreement entitled ‘Sublease.’ After referring to the Blood lease and the assignment thereof by petitioner to Jisco, and reciting that it was the desire of petitioner to mine the coal covered by the lease, this instrument provided that Jisco granted to petitioner the right to enter upon the premises described in the Blood lease (which was attached and referred to as Exhibit A) and to mine and remove the coal therefrom that could be mined by the strip-mining method. Petitioner was to place on the premises all necessary facilities, including strip roadway, machinery, and tipple equipment for the purpose of uncovering, mining, screening, and loading the coal mined, all to be done in accordance with and under the provisions of the Blood lease. This instrument further provided that all coal produced thereunder which was usable by Jisco should be sold to Jisco, which was to be the sole judge of what coal was usable by it. Coal not usable by Jisco could be sold by petitioner as he saw fit except that Jisco was given the first right and option to purchase such coal at a mutually agreed upon price. It was also provided that Jisco was to pay petitioner for the coal mined by petitioner which was usable by Jisco in its blast furnaces the market price based upon a present price of $4.90 per ton at petitioner's tipple, the price to vary up and down as the base price varied.

This sublease also provided that petitioner was to pay Jisco a royalty of 30 cents per ton for each ton of coal produced, on or before the 15th day of each month. If money was due petitioner from Jisco for coal purchased during any month, the amount was to be deductible therefrom by Jisco, otherwise the royalty was to be paid by petitioner to Jisco by the 15th day of each month. Petitioner was also to uncover all of the strip coal that could be mined up to a depth of 40 feet ‘overburdened’ and was also given the right to uncover strip coal up to 6,000 tons when Jisco was not using it but such coal was to be uncovered under the directions and within the limits prescribed by Jisco. Jisco agreed to advance to petitioner the sum of $2.50 per ton for all coal so uncovered. Jisco was obligated to take only such coal as was usable in its blast furnaces in Jackson, Ohio, and was not obligated to take any coal beyond its normal requirements as it might determine.

On August 4, 1952, Jisco purchased the Blood property for a consideration of $27,000 in order that Jisco could better control the coal underlying the property. At about the same time Jisco had the property core drilled to determine the number of tons of coal underlying the property, which was determined to be in the neighborhood of 106,000 tons. Jisco allocated $24,300 of the purchase price to the coal and thereafter claimed cost depletion ² on all coal mined and removed from the property at the rate of 23 cents per ton. At no time did Jisco claim percentage depletion on the coal mined from the Blood property.

In an instrument entitled ‘Article of Agreement,‘ dated September 16, 1955, between Jisco, as party of the first part, and Ramey, as party of the second part, reference was first made to the fact that Ramey had for some years past been a ‘producer, for and on behalf of the Company, of coal’ which was highly suitable for use and had been used by Jisco, and then recited that it was desirable that Jisco be assured as large a supply of such coal from the mines and operations of Ramey as Ramey should be able to produce and supply under present conditions, and the parties desired to contract with reference thereto. It was thereafter mutually covenanted and agreed:

(1) Ramey agreed to produce, sell, and deliver, free on board trucks of Jisco at his mine pits, and Jisco agreed to buy and receive from Ramey, such Jackson County No. 1 coal as may be required for the operation of its blast furnaces located at Lick Township, under terms and conditions therein set forth, for a period of 1 year from the date thereof, provided, however, the contract should remain in full force and effect from year to year thereafter unless terminated by either party giving notice in writing to the other 60 days prior to the expiration date of any contract year.

(2) The quantity of coal to be delivered by Ramey and received and paid for by Jisco was so much of the coal produced by Ramey as might be required by Jisco, using maximum requirements then estimated by the parties to be 2,000 tons per month.

(3) The quality and character of the coal to be delivered was to approximate that theretofore delivered by Ramey to Jisco; Jisco was entitled to test each load of coal upon receipt thereof at its blast furnaces and if such coal did not meet its requirements Ramey was given 10 days within which to correct the condition after which Jisco could cancel the contract in the event the condition was...