Guanacevi Mining Co. v. Commissioner

GUANACEVI MINING COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Guanacevi Mining Co. v. Commissioner

Docket Nos. 99764, 101902, 102712.

United States Board of Tax Appeals

43 B.T.A. 517; 1941 BTA LEXIS 1492;

February 4, 1941, Promulgated

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1. Expenditures for tunnels, equipment, and a mill necessary to extract ore profitably from a mine previously worked by primitive methods, held, a capital investment recoverable through depletion allowances and not a deductible operating expense.

2. Interest paid on borrowings for the development of a mine, held, to reduce the net income of the property for purposes of computing the deduction for percentage depletion. Mirabel Quicksilver Co.,41 B.T.A. 401">41 B.T.A. 401, followed.

3. No credit under section 26(c)(1), Revenue Act of 1936, is available to a taxpayer because the payment of a dividend was forbidden by state law. Helvering v. Northwest Steel Rolling Mills, Inc.,311 U.S. 46">311 U.S. 46; Crane-Johnson Co. v. Helvering,311 U.S. 54">311 U.S. 54.

Nathan Moran, Esq., for the petitioner.

E. A. Tonjes, Esq., for the respondent.

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STERNHAGEN

The Commissioner determined deficiencies of $3,083.58, $5,677.76, and $6,904.16 in petitioner's income taxes for 1935, 1936, and 1937, respectively. Petitioner assails (1) the disallowance, as an expense of mining operations, of a portion of expenditures for tunnels, a mill and equipment allocated by it to ore extracted in the taxable years, and (2) the deduction of interest on borrowed money in arriving at net income from the property for the purpose of computing percentage depletion.

FINDINGS OF FACT.

Petitioner, a California corporation with principal office at San Francisco, is the owner of a mining property in the State of Durango, Mexico. The property has been worked since Spanish colonial times, yielding silver and a small amount of gold. It lies in a region difficult of access, and before 1931 the ore was primitively extracted under the "gambucino" method by workers who brought it out in cowhide baskets.

1. Petitioner leased the property in 1905 and thereafter received royalties on the ore extracted. By 1929 the exhaustion of high grade ore made primitive operation unprofitabel, and petitioner made a survey to determine whether available low grade ore was sufficient to warrant an investment in modern machinery, tunnels, and a mill. In the course of this survey an assay plant was constructed; some 10,000 samples from borings were analyzed, and in 1931 the surveying engineer recommended expendiures for further operation on the basis of his estimates of available minerals. Some of the ore bodies examined in the survey were the same as had already been mined by primitive methods; there were some small discoveries.

On July 20, 1931, petitioner terminated the lease, and with borrowed capital proceeded to drive two tunnels into separate ore bodies that had been worked near the surface and to construct a mill to which the ore could be hauled on cars. No new bodies of ore were discovered and none was expected to be discovered in the course of driving the tunnels. The mill was complete and production began August 1, 1934. On that date petitioner had spent $123,785.45 on the mill, tunnels, and operating devices; during the remainder of the year it spent $11,045.25 on development; in 1936 it spent $6,858.59, and in 1937, $6,154.74. Available ore was first estimated at 122,947 tons; this estimate was increased in 1936 by 9,278 tons and in 1937 by 7,214 tons. In 1934 petitioner extracted 8,940 tons; in 1935, 24,645; in 1936, 30,076; in 1937, 33,494; and in 1938, 32,822. The mine, now nearing exhaustion, produces about 300 tons a month. After exhaustion the tunnels will be of no use.

2. On December 31, 1935, 1936, and 1937, the unpaid amounts of the borrowings with which petitioner had constructed the tunnels, mill, and operating equipment were $300,133.95, $255,038.41, and $200,465.15, respectively. During these years petitioner paid interest of $15,337.93, $11,963.26, and $7,235.87, respectively, which it treated as a capital expenditure in computing its allowance for depletion. Depletion deductions, computed on the basis of a percentage of income from the property, were claimed and allowed.

3. Petitioner has paid no dividends. Its indebtedness in October 1940 was about $51,000. Its only source of income is its Mexican mining operation.

OPINION.

STERNHAGEN: 1. On its income tax returns for 1935, 1936, and 1937 petitioner claimed as deductible mining expense $27,027.11, $31,971.93, and $34,936.20, respectively, representing an apportionment of its expenditures for mill, tunnels, and operating devices based on the amount of ore extracted in each year. The Commissioner disallowed these deductions on the ground that the expenditures "should be capitalized and recovered through deduction for depletion."

The petitioner treats the tunnels, mill, and equipment as if they were facilities acquired during normal production for the purpose of maintaining operations at normal production and did not increase the efficiency of operation or add to the value of the property. Upon that postulate the cost of the facilities would be brought within the doctrine of ; ; , and deductible as expense. The postulate is contrary to the evidence. The ore which was available for extraction by the primitive method had been practically exhausted in 1929, and petitioner terminated the lease in 1931. The survey was made to ascertain whether a new start by a different method was worth trying. The new cost was not to maintain production by continuing existing methods, but to institute a new method and provide for new production. In practical effect it was an investment in a new mining venture with a new period of development. It was not unlike the opening of a newly discovered mine. The expenditure was therefore a capital investment and not an ordinary and necessary expense of operation. See ; ; affd., ; ; . To one using the percentage method of depletion, the cost was recoverable through depletion out of income from the property.

The disallowance of the deduction as deferred expense of any part of such expenditures in the taxable years is sustained.

2. In computing the deduction for percentage depletion based on the net income from the property, the Commissioner treated the interest paid by petitioner on its borrowings as an expense of mining operations, thereby reducing the basic net income. Petitioner contests this reduction. The contention was considered in , and , and the taxpayer's position was rejected. The Commissioner's determination is sustained.

3. Petitioner claims a credit because it was forbidden by the California Code to pay a dividend. The contention is contrary to ; , and , and the Commissioner's determination is sustained.

Other matters have been settled by the parties and will be reflected in the computation of the redetermined deficiency.

Decision will be entered under Rule 50.