Vincent v. Commissioner

J. E. Vincent, et al., ^{Vincent v. Commissioner}

Docket Nos. 27877, 27878, 27879, 27880, 30435

United States Tax Court

19 T.C. 501; 1952 U.S. Tax Ct. LEXIS 11;

December 24, 1952, Promulgated

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Decisions will be entered under Rule 50.

1. Accrual Accounting -- Reserves for Backfilling. -- Estimated amounts for backfilling strip-mined coal lands are not deductible as accrued expenses where no backfilling has been done several years after completion of mining operations and where the obligation to do the backfilling has been assumed by others. Ralph L. Patsch, 19 T. C. 189, followed.

2. Deductions -- Overriding Royalties; Rental of Tipple. -- Deductions for overriding coal royalties and for rental of coal tipple held deductible on showing that accrued amounts were reasonable.

3. Depletion -- Gross Income from the Property. -- Amounts paid to strippers of coal on a per ton basis for coal mined and transported to railroad loading point, held, not to result in an economic interest in the strippers and amounts paid to them are not to be excluded from operators' gross income from the property in the computation of depletion deductions. Morrisdale Coal Mining Co., 19 T. C. 208, followed; James Ruston, 19 T. C. 284, distinguished.

4. Income -- Fair Market Value of Note -- Depletion. -- Note given as part consideration for assignment of leases held to have had fair market value equal to face amount and includible in income in year of receipt. Held, further, that the note did not give payee an economic interest in properties and depletion is not allowable in respect of the income.

5. Assignment of Income from Mining. -- A corporation controlled by the individual petitioner was organized for the purpose of operating coal properties under lease to the individual. The principal lease, by its terms, was not assignable to the corporation. The petitioner contracted with the corporation to continue to operate the properties, pay rentals and royalties, and to turn over the remainder of coal sales proceeds to the corporation which was to pay for the stripping. The petitioner continued to hold other properties in connection with the lease. Held, the petitioner retained sufficient rights in the income producing properties to warrant treating as his income all income from sales of coal, without reduction for amounts turned over to the corporation.

6. Depreciation -- Basis. -- Basis of coal tipple held to be the cost thereof at the time of acquisition even though prior owner's cost was a smaller amount.

Sidney B. Gambill, Esq., for the petitioners.

George C. Lea, Esq., for the respondent.

Arundell, Judge.

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ARUNDELL

The respondent determined deficiencies in income and profits taxes for the periods and in the amounts as follows:

Petitioner	Docket No.	Year or period
J. E. Vincent	27877	1945
J. E. Vincent	27878	1947
J. E. Vincent Co., Inc	27879	5-1-47 to 4-30-48
Gregory Run Coal Co	27880	6-11-45 to 12-31-45
		1946
J. E. Vincent Co., Inc	30435	5-1-48 to 1-3-49

Petitioner	Kind of tax	Amount
J. E. Vincent	Income	$ 3,385.50
J. E. Vincent	Income	211,117.12
J. E. Vincent Co., Inc	Income	11,789.69
	Income	4,022.10
Gregory Run Coal Co	Declared value excess profits	7,976.38
	Excess profits	50,163.63
	Income	17,111.53
J. E. Vincent Co., Inc	Income	37,090.62

The principal issues are whether Gregory Run Coal Company is entitled to deductions for estimated costs of backfilling strip-mined coal lands, and for overriding royalties and tipple rental; whether J. E. Vincent realized income on the receipt of a note in connection with assignment of leases; whether Gregory Run Coal Company, J. E. Vincent, and J. E. Vincent Company, Inc., should exclude from gross income from the mining properties the sums paid to coal strippers for mining and transporting coal; whether sums received by J. E. Vincent from sales of coal and paid over by him to J. E. Vincent Company, Inc., were income to J. E. Vincent or to the payee corporation; and whether for depreciation purposes the basis of a tipple purchased by J. E. Vincent Company, Inc., was cost or the basis in the hands of the transferor.

Some of the facts have been stipulated and, as stipulated, are found as facts.

FINDINGS OF FACT.

General Facts.

1. The petitioner J. E. Vincent, sometimes referred to herein as Vincent, is an individual who resides at Clarksburg, West Virginia. His wife is Grace Ott Vincent, who signs her name G. O. Vincent. His son, J. E. Vincent, Jr., was 27 years of age at the time of the hearing of these proceedings. Prior to the son's entrance into military duty in World War II, he had worked with his father in the coal business.

2. During the taxable years, the petitioner Vincent was engaged in the business of strip mining of coal in the area of Clarksburg, West Virginia. He pursued that business individually, under trade names, and as a stockholder and president of various corporations which he organized. Among the corporations that Vincent organized were Gregory Run Coal Company, Summit Fuel Company, and J. E. Vincent Company, Inc.

3. The petitioner Gregory Run Coal Company was organized under the laws of West Virginia on June 11, 1945. Its first Federal income tax return was filed for the period June 11, 1945 to December 31, 1945. Its subsequent returns were filed on the calendar year basis. Its books were kept and its returns were filed on the accrual method of accounting.

4. The petitioner J. E. Vincent Company, Inc., was organized under the laws of West Virginia on April 30, 1947. It filed its Federal income tax returns on a fiscal year basis beginning on May 1 and ending on April 30 of each fiscal year. Its first return was filed for the fiscal year beginning May 1, 1947, and ending April 30, 1948. Its books were kept and its returns were filed on the accrual method of accounting.

5. The petitioner J. E. Vincent filed his income tax returns on a calendar year basis and on the cash receipts and disbursements method of accounting.

6. The Federal income tax returns of all of the petitioners were filed with the collector of internal revenue at Parkersburg, West Virginia.

Backfilling Reserve (Gregory Run Coal Company).

7. Prior to the organization of Gregory Run Coal Company, the petitioner J. E. Vincent had acquired a number of coal leases which entitled him to strip mine coal on Gregory's Run in Eagle and Sardis Districts of Harrison County, West Virginia, which leases, for present purposes, are summarized as follows:

(a) A lease dated May 9, 1945, from Dawson Coal Company, a corporation, granted mining rights along an outcrop of approximately 17,750 feet and containing 25 to 30 acres. The original lease was for a term of two years with a provision for renewal for two additional years. The royalty provisions were a payment of 12 cents for each ton (2,000 pounds) of coal removed, with a minimum royalty of $ 250 a month beginning with July 25, 1945. The lessee, Vincent, was required to give the bond required by statute and to secure the required State permit for the strip-mining operations. The lease contained a provision against assignment or subletting, except that within 60 days from the date of the lease, the lessee could assign to a corporation "to be organized and controlled by him, which corporation shall expressly assume all the obligations" of the lease.

(b) A lease dated May 29, 1945, from Ai D. Ash and wife, granted strip-mining rights in Sardis District, Harrison County, West Virginia, at a royalty rate of 10 cents per ton of coal removed.

(c) A lease dated April 25, 1945, from Ernest L. Simpson and wife, granted the right to strip-mine some 82.746 acres in Harrison County, West Virginia, in consideration of the payment of 10 cents per ton of strippable coal mined and removed from the tract.

(d) A lease dated May 1, 1945, whereby persons surnamed Lindsay granted the right to strip-mine coal in consideration of 10 cents per ton of all coal mined, and one cent (1 cent) per ton of all coal transported over the land of the lessors.

8. By agreement dated May 9, 1945, the petitioner J. E. Vincent agreed to sell to J. H. Weaver Company, a corporation, "all of the strip coal that may be produced" by Vincent from the above leased premises. The J. H. Weaver Company agreed to pay to the petitioner J. E. Vincent for all coal mined, loaded into cars and accepted by the Weaver Company, "the prevailing maximum sale price of said coal, whether fixed by the Office of Price Administration or established by market conditions, less twenty-five cents (25 cents) a net ton of 2,000 pounds." The agreement contained provisions for adjustment in case of a decrease in the then maximum price of coal, or the production of coal that was not salable to Weaver Company's customers. Weaver Company was to pay Vincent on the 20th of each month for the coal accepted and sold by Weaver during the preceding month.

Vincent was to pay all rentals or royalties due to his lessors for the coal produced and sold to Weaver Company. Vincent was to use his best efforts to produce 25,000 tons of coal monthly from his stripping operations. Weaver Company was to use its best efforts to take all of the merchantable coal that Vincent could produce and load but did not guarantee to do so.

9. The Dawson lease, referred to in finding No. 7, related to a vein of outcropping coal which had been deep mined from the back. In deep mining it is ordinarily impossible to mine all the way to the surface, because the nature of the terrain is such that it will not support the roof of the mine. Where there has been deep mining, the vein may have been mined, or the part of the vein that remains and can be strip-mined may have deteriorated and become soft by reason of water running into it. In such a case, the quantity and quality of the coal in the vein cannot be determined until the overburden is removed by stripping.

10. Prior to incorporation of Gregory Run Coal Company on June 11, 1945, the petitioner Vincent, using stripping equipment rented from J. B. Williamson, had removed the overburden from a strip on the Dawson lease about 4,000 feet in length and 6 feet in width. That stripping disclosed the existence of coal estimated to amount to between 50,000 and 60,000 tons. The coal was in excellent condition and had not deteriorated by reason of the deep mining operations on the tract.

11. The petitioner Vincent had rented Williamson's equipment on a month-to-month basis. When Vincent had removed the overburden on the Dawson lease as described in finding No. 10, Williamson advised Vincent that he proposed to move his equipment to a job that he had in Pennsylvania. Stripping equipment at that time was scarce and Vincent could not find any other that was available to enable him to carry out his obligations under his coal leases. After considerable discussion, Vincent and Williamson worked out an arrangement under the broad lines of which a corporation would be organized to which Vincent would transfer his leases and Williamson would transfer his equipment. The detailed arrangements were as follows:

(a) Gregory Run Coal Company was to be organized under the laws of West Virginia. One-half of the stock was to be issued to Vincent and one-half to Williamson in consideration of the payment into the corporation of $ 500 by each of them.

(b) Vincent was to assign and transfer to the corporation all of the leases he then had and which he might later acquire; and also his agreement with J. H. Weaver Company to sell to it the coal mined from the leases. The considerations for such assignment and transfer were to be the assumption by the company of all rental and royalty payments under the leases, the assumption, performance and observation of all other payments, and obligations of covenants, conditions, and agreements of Vincent under the leases; the issuance of the company's negotiable promissory note to Vincent in the amount of $ 10,000 payable on or before July 1, 1947, with 6 per cent interest; and the payment of a royalty of 40 cents per ton of run of mine coal strip-mined, removed, and marketed from the leased properties.

(c) Williamson was to sell to Gregory Run Coal Company his strip-mining equipment at O. P. A. ceiling prices, payment therefor to be made by the corporation with its notes for $ 10,000 and $ 63,142.50.

12. Carrying out the arrangement between Vincent and Williamson, Gregory Run Coal Company was incorporated on June 11, 1945. On the following day, Vincent, Williamson and their attorneys were elected directors. Upon election of directors, Vincent offered to assign to the corporation his mining leases and others that might thereafter be acquired by him, and also his agreement with J. H. Weaver Company. Vincent's offer included the following provisions:

The consideration therefor shall be the assumption by Gregory Run Coal Company of all payments of rental and royalty becoming due to the respective lessors in each of said leases; the assumption performance and observation by said company of all other payments and obligations and of all covenants, conditions and agreements contained in said instruments on the part of the undersigned, J. E. Vincent, to be paid, kept, performed and observed; the sum of ten thousand dollars ($ 10,000.00), represented by a negotiable promissory note executed by said company to the undersigned, J. E. Vincent, in said sum of ten thousand dollars ($ 10,000.00), payable on or before July 1, 1947, with 6% interest, to be secured by a deed of trust on all of the foregoing properties; and also the payment by you to the undersigned, J. E. Vincent, as rental and royalty for said coal and mining rights and privileges to be assigned to you, a royalty of forty cents (40 cents) per ton of two thousand (2,000) pounds of run of mine coal mined by the strip mining process and removed and marketed from the above described premises, which said royalty payments shall be paid monthly to the undersigned, J. E. Vincent, not later than the 25th day of each month, for the coal mined and removed during the preceding month.

13. The directors of Gregory Run Coal Company formally accepted Vincent's offer, and Vincent, on the same date, June 12, 1945, made a formal assignment to the corporation of the properties described in his offer.

14. By written assignment dated July 2, 1945, J. B. Williamson conveyed to Gregory Run Coal Company his strip-mining equipment, which was listed and described in detail, at a price of $ 73,142.50. The purchase price was evidenced by the company's two promissory notes, one in the amount of $ 10,000 and the other in the amount of $ 63,142.50. In order to provide for the payment of the larger note, it was provided therein that the company would pay Williamson the sum of 23.8 cents per ton of coal mined from the leased properties, the payments to be made not later than the 25th of each month upon coal mined during the preceding month. This note was secured by a deed of trust to Williamson on the equipment purchased.

15. On July 2, 1945, Mrs. J. B. Williamson (described in the instrument as R. M. Williamson) formally conveyed to Gregory Run Coal Company equipment owned by her, which is listed and described in the bill of sale. The consideration therefor was $ 13,100, which was evidenced by the company's note in the amount of $ 13,100. Gregory Run Coal Company agreed to pay the note by the application thereto of 6 cents per ton of the coal mined from the leased properties. The note was secured by a deed of trust on the equipment.

16. In the leases assigned by Vincent to Gregory Run Coal Company, it was provided that Vincent would comply with all the laws and regulations of the State of West Virginia regarding the proper working of strip-mines and the backfilling and regrading after the coal was removed. The laws of West Virginia required the operator of a strip-mine to cover the face of the coal, regrade the overburden or other strata so as to refill any ditches, trenches, or excavations made in the stripping operation, and to plant trees, shrubs, grasses, or vines on the lands affected. Some of the leases provided for backfilling so as to restore the former contour of the land as nearly as might be practicable. In one lease the lessee was required to backfill so that all coal faces would be covered with at least three feet of settled clay, and upon completion of mining operations he was to backfill and regrade so that no water would accumulate or stand over, adjacent to or near the unmined coal.

17. On June 11, 1945, J. E. Vincent caused the incorporation of Summit Fuel Company under the laws of West Virginia. Vincent and Williamson each acquired 50 per cent of the stock of that corporation. On June 12, 1945, an agreement was entered into between Gregory Run Coal Company and Summit Fuel Company, which recited Gregory's holding of leases acquired from Vincent, Gregory's ownership of strip-mining equipment and possession of a tipple, Summit's ownership of motor vehicles and possession of labor personnel, and that Gregory and Summit had entered into a joint agreement for the mining on the leased properties, and the transportation and loading of the coal. It was provided that Gregory was to furnish all machinery and equipment for the use of Summit in the strip-mining operations. Summit was to provide all materials and motor vehicles for transportation of the coal, and all labor, and, with Gregory's machinery and equipment, was to mine and haul the coal and dump it at the Gregory tipple. Summit was to process the coal through the tipple and load it into railroad cars. Gregory was to market the coal. Gregory was to obtain the permit required by state law before mining operations were begun, and was to bear the expense of the bond. Section 13 of the agreement provided as follows:

Summit shall refill, regrade and recondition the surface of the mined area in accordance with the requirements of the laws of the State of West Virginia and all regulations duly issued thereunder, and in accordance with the requirements of the aforesaid leases, assignments and agreements, but the cost thereof shall be paid by Gregory.

18. Gregory Run Coal Company in its Federal income tax return for the period June 11, 1945, to December 31, 1945, and in its return for 1946, respectively, claimed deductions for reserves for backfilling in the respective amounts of $ 14,352.15 and $ 22,354.30. The amounts of such reserves were computed by the company on the basis of an estimated cost of 10 cents per ton of coal mined during the respective periods. No backfilling was done by or for Gregory Run Coal Company during either of the taxable periods. The respondent disallowed the claimed deductions.

19. On February 24, 1947, Gregory Run Coal Company assigned to Coal Service Corporation all of its coal leases, including those acquired from Vincent in 1945. The assignee agreed to substitute its bonds for those filed by Gregory Run Coal Company with the West Virginia Department of Mines in connection with strip mining permits for the purpose of "exoneration of the Assignor (Gregory Run) from liability under said bonds * * *." Gregory Run Coal Company agreed to indemnify the assignee against loss or liability arising out of Gregory Run's operations on the leased premises except with respect to claims of lessors "based on alleged failure by the Assignor to comply with the requirements of said leases as to backfilling and restoring the property * * *."

Overriding Royalty Deduction (Gregory Run Coal Company).

20. Part of the consideration for the assignment by J. E. Vincent of his leases and coal sales contract to Gregory Run Coal Company on June 12, 1945, was the agreement of Gregory Run Coal Company to pay to Vincent "as rental and royalty" the following:

* * * a royalty of forty cents (40 cents) per ton of two thousand (2,000) pounds of run of mine coal mined by the strip mining process and removed and marketed from the above described premises, which said royalty payments shall be paid monthly to * * * J. E. Vincent * * *.

21. In the arrangement between Vincent and Williamson which resulted in the organization of the Gregory Run Coal Company, it was agreed that Vincent was to receive from the company 20 cents per ton of coal mined as part of the consideration for his assignment of properties to it, and that Williamson was to receive 20 cents per ton as rental for the use by Gregory Run Coal Company of a tipple owned by Williamson. The amount of 20 cents per ton was reasonable for the use of the tipple. The amount of 20 cents per ton was a reasonable overriding royalty for assignment of the leases by Vincent to Gregory Run Coal Company.

22. Williamson did not want it known at that time that he was the recipient of rental for his tipple, and it was arranged that Vincent was to receive the 20 cents per ton rental payable to Williamson in addition to his own 20 cents per ton overriding royalty. As a step in carrying out that arrangement, Vincent, on July 9, 1945, executed a declaration of trust. The trust declaration referred to the assignment of June 12, 1945, from Vincent to Gregory Run Coal Company, to a supplemental assignment to Gregory Run Coal Company dated July 9, 1945, and to the overriding royalty reserved to Vincent. It then provided in material part as follows:

WHEREAS, in each of said transactions the said J. E. Vincent was acting for himself and for J. B. Williamson, * * *.

NOW, THEREFORE, I, The said J. E. Vincent, do hereby certify and declare that the Assignment dated the 12th day of June, 1945, * * * and the Supplemental Assignment dated the 9th day of July, 1945, * * * were executed and delivered as aforesaid, by the said J. E. Vincent, namely, myself, as trustee as herein set forth; and that in the execution and delivery of said instruments I, J. E. Vincent, acted as trustee for myself and for the said J. B. Williamson, and I hold all royalties and other moneys derived therefrom for the following persons:

1. J. E. Vincent	One-half
2. J. B. Williamson	One-half

I further certify and declare that I do not have, nor claim to have any personal or beneficial interest of any kind, nature or description in or to the undivided one-half interest in said property owned by the said J. B. Williamson.

I hereby agree to receive all money due as royalties under said instruments or any other instrument executed agreeable thereto, and to disburse the same as follows:

1. Deposit all of said money in a special bank account as such trustee.

2. Pay all expenses, including legal fees, taxes, etc., incident to the operation of this trust.

3. Distribute the balance forthwith, one-half to myself, J. E. Vincent, and one-half to J. B. Williamson.

23. In December 1945 Gregory Run Coal Company accrued on its books the sum of $ 57,449.66 as payable to J. E. Vincent pursuant to the provisions of the assignment from Vincent to it on June 12, 1945. It deducted that amount as royalties on its return for the period June 11 to December 31, 1945. The respondent disallowed the deduction. On March 13, 1946, Gregory Run Coal Company paid $ 57,449.66 to J. E. Vincent, trustee. On the same date, March 13, 1946, Vincent paid to J. B. Williamson one-half of said amount, namely, $ 28,724.83.

24. J. E. Vincent filed a fiduciary return for the year 1946 in which he reported the receipt of $ 57,449.66. He claimed a deduction for percentage depletion in the amount of $ 2,872.48, and reported the balance as distributable to himself and J. B. Williamson in the equal amounts of $ 27,288.59. In J. E. Vincent's individual income tax return for 1946, he reported the receipt of $ 27,288.54 (a difference of 5 cents) as income from a trust.

25. In March 1946 J. B. Williamson's 50 per cent stock interest in Gregory Run Coal Company was acquired by that corporation. No amounts were accrued or paid by Gregory Run Coal Company as overriding royalties after 1945. Neither Gregory Run nor Summit Fuel ever paid any dividends. Both corporations were liquidated in 1947 and their assets were distributed to Vincent.

26. The amount of $ 57,449.66, representing overriding royalties to Vincent at 20 cents per ton of coal mined in the taxable year ended December 31, 1945, and rentals to Williamson at 20 cents per ton of coal mined in that period, was an ordinary and necessary expense incurred by Gregory Run Coal Company for that period, and the respondent's disallowance of a deduction therefor was erroneous.

Depletion Allowable to Gregory Run (Exclusion from Gross Income of Payments to Summit Fuel).

27. The contract dated June 12, 1945, between Gregory Run Coal Company and Summit Fuel Company set forth the rights and obligations as to both corporations in the conduct of strip-mining operations under the leases assigned to Gregory Run by Vincent on June 12, 1945. It recited that the two corporations had entered into a "joint agreement" for the mining, transporting, and loading of coal at the tipple. Gregory Run was to furnish at its expense all machinery and equipment, except motor vehicles. Summit Fuel was to furnish at its expense all materials, tools, parts, motor vehicles for transportation of the coal, and all labor, and with the machinery and equipment furnished by Gregory Run, was to do all things necessary to strip-mine, haul, and dump at the tipple all of the mineable and merchantable coal. Summit Fuel was also to process the coal through the tipple and load it into railroad cars. Summit Fuel was to use its best efforts to keep the work continuously in operation, protect adjoining properties, and to observe all conditions of the leases, except for the payment of rents and royalties which were to be paid by Gregory Run. Summit Fuel was to carry workmen's compensation and public liability and property damage insurance. It was to indemnify and save Gregory Run harmless from all claims arising out of its operations.

Gregory Run was to obtain at its expense the necessary state mining permit, and was to bear the expense of the required bond. It was to market the coal through such selling agent as it might select.

Provisions as to disposition of proceeds of coal sales, and cancelation were as follows:

All money arising from the sale of said coal shall be paid to Gregory, and for its participation in this joint adventure Summit shall receive one and 55/100 dollars ($ 1.55) per net ton for all coal mined, transported and loaded by it, which shall be paid to it on the 25th day of each month for all coal mined and loaded during the preceding month. It is understood, however, that if either Gregory or Summit are dissatisfied with this distribution, then the dissatisfied party may serve written notice upon the other party to cancel this agreement, and thirty days after the service of said notice the agreement shall be cancelled and all rights hereunder terminated, except that in case Gregory serves said notice upon Summit, then Summit shall have the right to mine and remove all coal under which the overburden has been removed at that time, irrespective of said thirty day limitation.

The contract contained additional provisions permitting cancelation of the contract by either party in the event of default by the other.

28. During the period June 11, 1945, to December 31, 1945, Summit Fuel Company stripped and hauled coal from the leased properties, for which operations Gregory Run Coal Company paid it a total amount of $ 222,617.43. In 1946, Summit Fuel Company performed both stripping and hauling operations until July 1. Beginning July 1, 1946, Gregory Run Coal Company performed the stripping and Summit Fuel Company did only the hauling. For the calendar year 1946, Gregory Run paid to Summit Fuel $ 189,005.63 for stripping and $ 86,367.19 for hauling. The amounts set forth in this paragraph were reported as income by Summit Fuel Company for the years 1945 and 1946, and were claimed as deductions from gross income by Gregory Run Coal Company for 1945 and 1946 in computing net income from the property.

29. In the computation of percentage depletion allowable to Gregory Run Coal Company for the period June 11 to December 31, 1945, and for the calendar year 1946, the respondent determined that the amounts set forth in finding No. 28 should be excluded from gross income from the property.

30. Summit Fuel Company did not claim depletion deductions in its income tax returns.

$ 10,000 Note from Gregory Run to J. E. Vincent. Whether Income to Vincent, and if so, Whether Subject to Depletion.

31. The note of Gregory Run Coal Company to J. E. Vincent, issued as part consideration for Vincent's assignment of properties to Gregory Run, was in the principal amount of $ 10,000. It was payable on or before July 1, 1947, with interest. The rate of interest was not specified in the note. The agreement between Vincent and Gregory Run provided for interest at the rate of 6 per cent, and also provided that the note was to be secured by a deed of trust on all of the property assigned by Vincent to Gregory Run.

32. Among the assets owned by Gregory Run at the time it executed the note to Vincent was the contract with J. H. Weaver Company whereby Weaver Company agreed to pay the prevailing maximum sale price for all coal produced and loaded into cars. Gregory Run also had the leases assigned to it by Vincent, on which the overburden had been removed from some 50,000 or 60,000 tons of coal of good quality. Sales of coal by Gregory Run in the period June 11 to December 31, 1945, amounted to $ 377,750.67. Gregory Run paid its note to Vincent in February 1946.

33. The note of Gregory Run Coal Company to J. E. Vincent dated June 12, 1945, in the amount of $ 10,000 was issued as part of the consideration for the assignment to it of coal leases and other property. The note had a fair market value of $ 10,000 on the date it was received by Vincent.

Item of $ 808,064.46 Paid by Vincent to J. E. Vincent Company; Deduction Therefor by Vincent.

34. On October 29, 1945, J. E. Vincent entered into an agreement and lease with Dawson Coal Company, a corporation, wherein Vincent acquired the right to strip mine "All of the Pittsburg or Nine Foot vein or seam of coal remaining unmined which can or may be mined and removed by strip mining * * * situate along the outcrop of the coal on Lambert's Run in Eagle District, Harrison County, West Virginia, having a length along said outcrop of approximately 36,000 feet (being approximately 14,750 feet of solid coal outcrop, and 21,250 feet along the outcrop of areas previously deep-mined), and containing approximately 50 acres, more or less, of strippable coal * * *." The term of the lease was for two years, with the right of renewal for two more years on condition that Vincent should have removed at least 200,000 tons of coal in each year of the initial two-year period. Vincent was to pay to the lessor as "rental or royalty" 12 cents per ton of coal mined and removed, with a minimum of $ 500 a month. If such minimum monthly amount exceeded the amount payable on a tonnage basis, the excess was to be applied to rentals or royalties for subsequent months on a tonnage basis. Vincent was required to mine so as to obtain the maximum amount of coal recoverable, complying with all laws of the United States and West Virginia, and all regulations thereunder, regarding the proper working of strip-mines and the backfilling and regrading to be done after removal of the coal. Vincent was to give the bond and obtain the permit required by state law. He was to commence strip-mining operations at once and to pursue them with diligence and dispatch. Vincent was permitted, without releasing himself, to assign the lease within 60 days to a corporation to be organized and controlled by him, in which event the corporation was to assume all the obligations of the lease. He could also, without releasing himself, sublet or subcontract the stripping operations on not to exceed 50 per cent of the coal crop exposure covered by the lease.

35. On September 1, 1945, J. E. Vincent acquired from J. L. Thrasher and wife a lease covering the surface rights over the coal that was the subject of the Dawson Coal Company lease of October 29, 1945. Under that lease the lessee was to pay to the lessor "as compensation for said mining and stripping rights and privileges and other rights herein leased, eight (8 cents) cents a net ton" for coal not owned by the lessors which was mined from the leased premises, and if any coal owned by the lessors was mined, the lessee was to pay an additional sum of 15 cents for each ton mined. The lease was to inure to the benefit of and be binding on the heirs and assigns of the parties.

36. By written contract dated December 24, 1945, J. E. Vincent employed Swaney Contracting Company, a West Virginia corporation, to strip-mine coal covered by the Dawson and related leases on Lambert's Run. Swaney Contracting Company was to strip-mine the coal, and to haul it to a railroad siding and dump it into cars or onto a tipple at the siding. Vincent was to provide a suitable sidetrack and tipple, and he was to have complete charge of the tipple; he was to furnish and pay the men required for the operation of the tipple and sidetrack; he was to have complete charge of the coal after it was loaded or dumped at the tipple.

37. Under the agreement, Swaney Contracting Company was to conduct strip-mining operations with diligence and dispatch; it was to furnish adequate machinery, equipment, and employees to mine and haul 25,000 tons of coal a month; production was to be as continuous and uniform as practicable and reasonably possible. Swaney Contracting Company, in conducting mining operations and in backfilling and restoration, was to be bound by and comply with all of the terms of the leases under which Vincent was the lessee. It was to furnish to Vincent a performance bond in the penal sum of $ 2,500.

38. Vincent was to pay Swaney Contracting Company for its services the sum of $ 2 a net ton for all merchantable coal strip mined by Swaney and hauled to and loaded or dumped at the tipple or tipples provided by Vincent. There were provisions for adjustment of the basic payment of $ 2 per ton in the event of either a reduction or increase in the sale price of the coal.

39. Swaney Contracting Company was to secure and pay for all bonds required by the state and to secure the necessary state mining permits. In all respects, Swaney was to "operate as an independent contractor in conducting its operations" under the agreement. Swaney was to secure and keep in force, at its expense, adequate public liability and property damage insurance against loss or liability arising out of its operations. Vincent was to carry insurance in connection with his tipple and sidetrack operations.

40. Swaney Contracting Company was to be paid for its services on the basis of all coal accepted and paid for by Vincent's sales agent, Weaver Coal Company, but the failure of the sales agent to pay Vincent was not to relieve Vincent from his obligation to pay Swaney for its services.

41. Under the contract, Vincent was responsible for the payment of royalties for the coal and surface rights under his leases. The contract was not cancelable except on specified defaults by the parties, or in the event of reduction in sales price of the coal below $ 2.76 per ton and failure of the parties to renegotiate the contract. The contract provided for arbitration of disputed matters.

42. On April 26, 1947, J. E. Vincent entered into a coal stripping agreement with B. H. Swaney and Son, Inc., another West Virginia corporation, herein sometimes called Swaney, Inc., with respect to the Lambert's Run property. Under that contract Swaney, Inc., was "employed as contractor for the purpose of stripping, loading and hauling to said tipple [operated by Vincent] all the coal leased" to Vincent by Dawson Coal Company which is "not now being operated by another contractor under a prior agreement * * *." The provisions of the contract were similar to those of the contract of December 24, 1945, between Vincent and Swaney Contracting Company, except that the compensation to Swaney, Inc., was to be at the rate of $ 2.18 per ton for coal mined and hauled to Vincent's tipple. ^{*42 43. Swaney Contracting Company and B. H. Swaney and Son, Inc., complied with the terms of their agreements with Vincent. Each of the companies filed with the state the bond required as a condition of the operation of strip-mines. The market price of coal increased during the period that the two Swaney companies were engaged in strip-mining on the Vincent leases, and each of the companies received compensation for their services in excess of the base amount per ton that was specified in the contracts.}

44. Prior to April 30, 1947, J. E. Vincent had been engaged in the business affairs. His son, J. E. Vincent, Jr., returned from military E. Vincent Company. After he had operated for a while on the Lambert's Run property under the Dawson Coal Company lease of October 29, 1945, he became ill and was unable to look after his business affairs. His son, J. E. Vincent, Jr., returned from military service and did some work on the Lambert's Run property. Vincent felt that his son should have an interest in the business, and decided to, and did, organize J. E. Vincent Company, Inc., on April 30, 1947. Upon organization of that corporation, J. E. Vincent acquired 60 shares of its stock and his wife and son each acquired 10 shares. The purpose of organizing the corporation was to have it take over Vincent's interest in the Lambert's Run property and to operate the property under the leases.

45. J. E. Vincent requested Dawson Coal Company to permit an assignment to J. E. Vincent Company, Inc., of the strip-mine lease on the Lambert's Run property. Dawson Coal Company refused to permit the assignment. Vincent so reported to the directors of J. E. Vincent Company, Inc., at a meeting on May 15, 1947. The directors thereupon agreed "that the corporation would operate the said coal without a formal assignment of the leases * * * on the same basis as said operations would have been conducted if said assignment had been made * * *."

46. On the same date as the meeting of the directors, May 15, 1947, an agreement was entered into between J. E. Vincent and J. E. Vincent Company, Inc. (herein sometimes called Vincent, Inc.). Under the agreement, Vincent leased to Vincent, Inc., a tipple, sidetrack, buildings, ground, and appurtenances thereto, and granted to it the right to load over the tipple the coal mined from the properties under lease to Vincent on Lambert's Run and any other coal in that territory under lease to Vincent. For the use of the tipple and related properties Vincent, Inc., was to pay a rental or royalty of 5 cents for each ton of coal loaded at the tipple, which sum was to be retained by Vincent from each monthly settlement that he was to make with Vincent, Inc. Costs of operating and maintaining the tipple and appurtenant properties were to be borne by Vincent, Inc. Vincent was to continue to operate in his own name the Lambert's Run strip-mines, and was to "be regarded as the operator of said coal" subject only to the contract between him and B. H. Swaney and Son, Inc., dated April 26, 1947. Vincent was to receive payment "from his sales agent" for all coal loaded over his tipple and sidetrack, and out of the proceeds of such sales he was to "pay brokerage, royalties for coal, surface rights, rights of way, rental on sidetrack property and buildings, and other similar royalties." After deducting all such payments and charges, Vincent was to pay the net proceeds from sales of coal to Vincent, Inc. The term "net proceeds" was stated to mean the amount left in the hands of Vincent "after paying all such royalties and rentals and after deducting taxes chargeable by the State of West Virginia on mining operations." Out of such net proceeds, Vincent, Inc., was to pay to B. H. Swaney and Son, Inc., the amounts payable to it under its stripping agreement with Vincent. The contract between Vincent and Vincent, Inc., was cancelable by either party on 30 days' notice.

47. In 1947, between the time the contract of May 15, 1947, was entered into by Vincent and Vincent, Inc., and December 31, 1947, Vincent paid to Vincent, Inc., the sum of $ 808,064.46 as representing the "net proceeds" of sale of coal as defined in the contract. The payments were made by checks drawn by Vincent on his bank account on the dates and in the amounts as follows:

Date	Amount
June 30, 1947	$ 74,399.16
July 31, 1947	103,009.01
Aug. 31, 1947	1,382.08
Aug. 31, 1947	93,443.83
Sept. 30, 1947	108,969.19
Oct. 31, 1947	129,780.00
Nov. 30, 1947	131,100.29
Dec. 31, 1947	165,980.90
Total	$ 808,064.46

In addition to the above payments, Vincent paid to Vincent, Inc., the sum of $ 146,823.40 in January 1948, which sum represented the net proceeds from sales of coal that were made in December of 1947 but not collected until January of 1948.

48. J. E. Vincent paid Swaney Contracting Company $ 242,225.36 and B. H. Swaney and Son, Inc., $ 6,368.96 for coal stripping that they did prior to May 1, 1947, pursuant to his contracts with them dated December 24, 1945, and April 26, 1947.

49. In the periods May 1, 1947, to December 31, 1947, and January 1, 1948, to April 30, 1948, J. E. Vincent Company, Inc., paid to the Swaney companies for coal stripping that those companies performed the following amounts:

	May 1, 1947, to	Jan. 1, 1948, to
	Dec. 31, 1947	April 30, 1948
Swaney Contracting Co.	$ 101,669.65	$ 153,829.60
B. H. Swaney & Son, Inc.	346,709.60	121,159.30

The amounts of $ 101,669.65 and $ 346,709.60 that were paid to the Swaney companies in 1947 were among amounts claimed as deductions from gross income by J. E. Vincent Company, Inc., in its return for the fiscal year ended April 30, 1948. Total deductions claimed by J. E. Vincent Company, Inc., for the period May 1 to December 31, 1947, as expenses paid, amounted to $ 565,743.67. *47 J. E. Vincent Company, Inc., maintained a complete set of books showing the results of its operations. It maintained its own bank account.

50. On December 1, 1947, Vincent gave written notice to Vincent, Inc., of his election to cancel and terminate, effective January 1, 1948, the agreement between them dated May 15, 1947. At about that time Vincent was given to understand that Dawson Coal Company would offer no objection to an assignment of the lease by Vincent to Vincent, Inc. By agreement of January 2, 1948, Vincent assigned to Vincent, Inc., his strip-mining and surface leases on the Lambert's Run properties, including all grants or leases of rights of way or easements in any manner appurtenant to the Lambert's Run operations. The assignment was specifically subject to the strip-mining employment contract between Vincent and B. H. Swaney and Son, Inc., of April 26, 1947. After the assignment Vincent, Inc., collected for the sales of coal.

51. The amounts aggregating $ 808,064.46 that were paid by Vincent to Vincent, Inc., in 1947 constituted income of Vincent.

52. During the period May 1, 1948, to January 3, 1949, B. H. Swaney and Son, Inc., performed strip-mining operations on the Lambert's Run property. In that period it received compensation for such services from J. E. Vincent Company, Inc., in the amount of $ 509,765.46. The services were performed pursuant to the contract of April 26, 1947, between J. E. Vincent and B. H. Swaney and Son, Inc.

In determining the amount of depletion allowable to Vincent, Inc., for the period May 1, 1948, to January 3, 1949, the respondent excluded from income from the property the amount of $ 509,765.46 paid to B. H. Swaney and Son, Inc.

53. In January 1949 B. H. Swaney and Son, Inc., purchased from Vincent, Inc., the strip-mine leases on the Lambert's Run property.

54. Vincent, Inc., was liquidated on January 3, 1949. J. E. Vincent reported a capital gain of $ 82,644.02 as realized on the liquidation of his stock in the corporation.

Basis for Depreciation of Tipple (J. E. Vincent Co., Inc.).

55. By instrument dated January 2, 1948, J. E. Vincent sold to J. E. Vincent Company, Inc., his coal tipple, appurtenant screening plant, railroad siding, and leases at Erie, West Virginia, herein called the Erie tipple. The consideration for the sale was $ 125,000 which was paid to Vincent. A gain on the sale was reported in the joint income tax return of Vincent and his wife for the year 1948.

56. The tipple was on the main line of a railroad. It had been constructed by Vincent in 1946 on the site of an old tipple where there had been a deep mine. There were cement piers in place and they were utilized by Vincent. About half of the needed grading for a railroad siding had been done. Vincent completed the grading, constructed the siding with material purchased by him, improved an access road, and constructed a 60-ton bin and a crusher with belt feed between them. The total cost to Vincent of the Erie tipple, siding, and appurtenances was $ 78,440.

57. During the calendar year 1948, there were 257,525 tons of coal handled over the Erie tipple. The coal was sold for $ 1,253,733.42, an average price of $ 4.86 per ton. Unscreened run of mine coal sold at an average price of $ 3.82 a ton in 1948. The cost of operating the tipple was about 20 cents per ton of coal handled over it.

58. Fire insurance policies on the Erie tipple at the time of its sale to Vincent, Inc., were in the face amount of $ 30,000. The tipple was valued for local tax purposes at $ 30,000.

59. J. E. Vincent Company, Inc., was liquidated on January 3, 1949, and the Erie tipple, with appurtenances, was distributed to its stockholders. The stockholders shortly thereafter sold the tipple and appurtenances for the sum of $ 24,000.

60. J. E. Vincent Company, Inc., in its income tax return for the fiscal year ended April 30, 1948, claimed a deduction for depreciation of the Erie tipple (under the designation of "Amortization of Leasehold Improvements") in the amount of $ 22,000. The explanation given was that the rate was determined:

* * * by amount of strippable coal available and now under lease. At present production levels, all coal will be stripped and loaded prior to September 1, 1949. No further leases available within economical hauling distance of tipple and siding.

In its return for the period ended January 3, 1949, (the date of liquidation) Vincent, Inc., claimed a deduction for depreciation of the Erie tipple (under the designation of "Amortization of Leasehold") in the amount of $ 78,000. The explanation given was:

Amortization taken on Erie Tipple and Siding in the amount of $ 78,000.00 to adjust book value to Engineers estimate of salvage or sales value of $ 25,000.00 at close of operations, January 3, 1949.

61. For the fiscal year ended April 30, 1948, and the period ended January 3, 1949, the respondent allowed, respectively, the amounts of $ 4,897.64 and $ 9,795.24 as deductions for amortization of the Erie tipple. The explanation in the notices of deficiency for both periods was that the basis for the tipple, scales, and railroad siding was $ 44,488.03, "the same as in the hands of the transferor, J. E. Vincent, and that this basis, less $ 20,000.00 salvage value is recoverable over a twenty-month period."

62. In the joint income tax return of J. E. Vincent and his wife for the calendar year 1949, the sale of the Erie tipple and siding for $ 24,000 was reported, and the basis was shown as being in the amount of $ 25,000.

63. The basis of the Erie tipple and appurtenances to J. E. Vincent Company, Inc., for depreciation was the cost thereof in the amount of $ 125,000.

OPINION.

The parties have settled by stipulation issues which involved comparatively small amounts and which concerned deductions for traveling expenses and the cost of small tools. An error alleged as to amortization of leaseholds in Docket No. 27880 was withdrawn by the petitioner.

The remaining issues will be considered in the order in which they are presented by the parties in their briefs.

Deductions for Reserves for Backfilling.

In its returns for 1945 and 1946, Gregory Run Coal Company deducted as items representing a part of the cost of sales, the respective sums of $ 14,352.12 and $ 22,354.30 which were designated "Cost of Back Fill." The respondent restored those amounts to income in his determination of the deficiencies, and his action in that respect is assigned as error by Gregory Run Coal Company in Docket No. 27880.

The claimed deductions have their origin in statutes of West Virginia concerning strip-mining, and leases under which J. E. Vincent was granted the right to strip-mine coal on several tracts in the Eagle and Sardis Districts of Harrison County, West Virginia.

The statutes of West Virginia*53 operator the duties, among others, of covering the face of the coal on mined areas, regarding the overburden removed in a manner approved by the Department of Mines and agricultural experiment station, and to fertilize and plant trees, shrubs, grasses, or vines on the lands affected in accordance with regulations of the Department of Mines and agricultural experiment station. If an operator fails to comply with the provisions of the statute, his permit may be revoked and his bond forfeited.

Vincent's leases required him to comply with state law and regulations as to backfilling and regrading, and some required restoration of the original contour of the land. By the acceptance by Gregory Run Coal Company of Vincent's assignment of his leases, that company assumed the performance of all of his obligations.

The amounts claimed as deductions by Gregory Run Coal Company do not represent expenditures for backfilling. They are estimates of such cost computed at the rate of 10 cents per ton of coal mined. It was stipulated by the parties that at the time of the hearing of these proceedings no backfilling had been done by or on behalf of the Gregory Run Coal Company.

We conclude that the respondent properly disallowed the claimed deductions for the estimated costs of backfilling. The basic facts in these proceedings are not distinguishable from those in the case of Ralph L. Patsch, 19 T. C. 189. In both cases the lessees were obligated by the terms of their leases and by state law to backfill areas that had been strip-mined. In both, the obligation had been assumed by others, at least partially. In both, backfilling had not been completed several years after mining operations had been completed, despite time limitations imposed by state law. In the Patsch case, we pointed out that the obligation that is necessary to support an accrued deduction is an obligation to pay. An obligation to perform services at some indefinite time in the future will not justify the current deduction of a dollar amount as an accrual. See cases cited and discussed in the Patsch case, supra.

The petitioner, Gregory Run Coal Company, relies on the case of Harrold v. Commissioner, 192 F. 2d 1002, to support its claim for allowance of the deductions. The decision of the Circuit Court of Appeals in that case rests on facts that are different from those before us. There the mine operator made an estimate at the end of the year in which operations were completed, the amount of which was based on a number of years of experience of one of the mining partners. The backfilling was actually started as early in the following year as weather conditions would permit, and was completed within that year. The amount claimed as a deduction was limited to the amount actually expended for backfilling, although a larger estimated amount had been claimed in the return that was filed for the year prior to that in which the backfilling was done. The Circuit Court, in allowing the deduction, called attention to cases cited by the Supreme Court in Lucas v. American Code Co., 280 U.S. 445">280 U.S. 445, where although liability to pay an ascertained amount had not been incurred with unalterable finality, nevertheless there was an imminent, recognized liability to pay a sum susceptible of reasonable ascertainment as to amount, and payment was actually made shortly thereafter. Cases of this kind were recognized by the Supreme Court in the American Code Co. case as constituting an exception to the general rule under which deductions for expenses, taxes, and similar items are allowed under the accrual method only where the facts establish the existence of a definite liability to pay an established or ascertainable amount. The Circuit Court in the Harrold case apparently found that the facts before it were sufficient to bring the case within the exception recognized in the American Code Co. case. In these proceedings, we are unable to find facts sufficient to say that in the years 1945 and 1946 Gregory Run Coal Company had incurred a definite liability to pay a fixed or reasonably ascertainable amount for the backfilling of the mined areas. These proceedings come within the purview of the case of Ralph L. Patsch, supra, and cases cited therein, principally Brown v. Helvering, 291 U.S. 193">291 U.S. 193; Spencer, White & Prentis v. Commissioner, 144 F. 2d 45;Amalgamated Housing Corporation, 37 B. T. A. 817; and Atlas Mixed Mortar Co., 23 B. T. A. 245.

There is present here, as in the Patsch case, the element of assumption of liability by others. As shown by the findings, Summit Fuel Company, as a part of its mining operations, undertook to backfill the mined areas. True, any backfilling performed by it was to be at the expense of Gregory. But Gregory's liability under that agreement was only one of reimbursement to Summit if and when Summit backfilled. This is far from fixing on Gregory in the taxable years a definite liability to pay a fixed or ascertainable amount. Further, in 1947, Coal Service Corporation came into the picture and relieved Gregory Run of its liability to backfill.

Accordingly, the issue as to deductions by Gregory Run Coal Company for estimates of cost of backfilling is decided for the respondent.

Gregory Run Coal Company -- Deductions for Overriding Royalties to J. E. Vincent; and for Tipple Rental to J. B. Williamson.

The issue here is whether Gregory Run Coal Company may deduct, as royalties and rentals, the gross sum of $ 57,449.66, which was paid to Vincent in March 1946, and which in turn he divided with Williamson.

It is the undisputed testimony of Vincent that at the time Gregory Run Coal Company was organized it was understood that he was to receive an overriding royalty of 20 cents per ton for each ton of coal mined, and that Williamson was to receive an equal amount for each ton that went over his tipple, cleaning plant and siding. Vincent's agreement with Gregory Run Coal Company stated that he was to receive 40 cents per ton of coal mined. Thereafter, on July 9, 1945, Vincent executed a declaration of trust whereby he declared himself to be a trustee for Williamson to the extent of one-half of the proceeds from the 40 cents royalty to be received from the leases that he assigned to Gregory Run Coal Company.

Royalties, on the accrual method, under the assignment by Vincent, amounted to $ 57,449.66 which the respondent disallowed as a deduction to Gregory Run Coal Company. The respondent's position, in brief, is that said amount did not represent bona fide royalties and rentals but instead amounted to a division of profits between Vincent and Williamson.

We think that the respondent erred in his disallowance of the claimed deduction. It may be that under other circumstances Gregory Run would not have paid an overriding royalty of 20 cents per ton, nor 20 cents per ton for the rental of a tipple. But we must take the facts as we find them and we do not find therein any evidence to establish a lack of bona fides. Vincent had leases that he was required to operate in order to retain them. At his own expense he had uncovered a large block of merchantable coal. He was entitled to some consideration for that work which added to the value of Gregory Run's holdings. The respondent points to the royalties payable to Vincent's lessors as an indication that a 20 cent overriding royalty was not within reason. The most substantial of the leases had been entered into prior to the completion of Vincent's exploratory work. The others in the Eagle and Sardis districts appear to have been fill-in leases made to round out the Dawson lease which was the major one. Royalties under other leases made in the year 1945 in the same county ranged from 25 cents to 49 cents per ton for mineral and surface rights.

Williamson's tipple was available for use by Gregory Run Coal Company, and the evidence is that there was only one other that could have been used and its use would have cost much more than the 20 cents per ton charged by Williamson. There is some evidence that one other tipple, a smaller one, had been rented at the rate of 5 cents per ton, but the owner soon found that that rate was too low and canceled the rental agreement. Gregory Run Coal Company used Williamson's tipple and paid for such use at the rate of 20 cents per ton of coal loaded over it. We are satisfied that that was a reasonable rental, and the amount paid was an ordinary and necessary business expense.

Exclusion from the Statutory Definition of "Gross Income from the Property" of Amounts Paid to Summit Fuel Company.

The findings of fact that we have made show that for the period ended December 31, 1945, Gregory Run Coal Company paid the sum of $ 222,617.43 to Summit Fuel Company for the strip-mining of coal from the Dawson and related leases. For the calendar year 1946, amounts aggregating $ 275,372.82 were either paid or properly accrued. There is some discussion, and some evidence, on the point of whether all of the amount paid for 1946 was for strip-mining or whether some part of it was paid for only hauling. These matters are beside the point for decision.

The starting point for the computation of the amount allowable for depletion of coal mines is "the gross income from the property during the taxable year * * *." Internal Revenue Code, section 114 (b) (4) (A). In applying that term to oil and gas properties, it has been said that it means "gross income from oil and gas * * * and the term should be taken in its natural sense." Helvering v. Mountain Producers Corporation, 303 U.S. 376">303 U.S. 376. Section 29.23 (m)-1 (f) of Regulations 111, Supplement, provides in part as follows:

In the case of a crude mineral product other than oil and gas, "gross income from the property" * * * means the gross income from mining. * * *

If the taxpayer sells the crude mineral product of the property in the immediate vicinity of the mine, "gross income from the property" means the amount for which such product was sold, * * *.

We think that in determining Gregory Run's gross income from the Eagle and Sardis district properties, the respondent erred in excluding the amounts that were paid to Summit Fuel Company. The contract between Gregory Run and Summit Fuel contained the following provision:

Gregory shall market said coal through such selling agent as it may select.

The respondent does not contend that Gregory Run did not sell the coal that was produced in the years 1945 and 1946. His argument, summarized, is that Summit Fuel Company had an economic interest in the coal which entitles it to deductions for depletion. This argument is based in part on statements in the contract between Gregory Run and Summit Fuel wherein the parties refer to "each joint adventurer," and that they have contributed to the "joint enterprise." These expressions are not conclusive of the intent of the parties judged by the provisions of the contract as a whole. As we have shown, the contract provided that Gregory Run was to sell the coal. It was also provided that all money arising from the sale of the coal was to be paid to Gregory Run. Summit's only interest was to receive $ 1.55 per net ton for coal that it mined, transported, and loaded. The wording on this point is carefully spelled out. It is:

* * * for its participation in this joint adventure Summit shall receive one and 55/100 dollars ($ 1.55) per net ton for all coal mined, transported and loaded by it * * *.

In Morrisdale Coal Mining Co., 19 T. C. 208, we held that the respondent erred in excluding from a mining lessee's income from coal properties the amounts that it paid to strippers under several contracts. The contracts there under consideration were generally similar to that between Gregory Run and Summit Fuel in that under them the stripping contractor was engaged to strip-mine coal from designated tracts, and to haul and load it into railroad cars at specified points. For such services, the stripping contractors were to receive a specified amount per net ton of coal strip-mined and loaded into railroad cars. There were minor points of distinction between the several contracts in that case, such as the facts that gave rise to a right of termination, the amount of overburden required to be removed, and the right of the employing operator to designate points of mining and loading.

Upon examination of the several stripping contracts in the Morrisdale Coal case, supra, we concluded that none of them granted to the stripping contractors an economic interest in the coal in place, and for that reason no apportionment of the gross income from the property was to be made between the employing contractor and the stripping contractor. In that case, analyzing two of the stripping contracts, we said in part:

Most of the cases in which depletion has been allowed to an independent contractor have involved situations where the producer or miner of the mineral or other depletable asset has received payment either in kind or as a percentage of the ultimate selling price or profit derived from the sale of the commodity. Spalding v. United States (C. A. 9, 1938), 97 F. 2d 697, certiorari denied 305 U.S. 644">305 U.S. 644 (1938); cf. Edward J. Hudson, 11 T. C. 1042 (1948), affd. (C. A. 5, 1950) 183 F.2d 180">183 F. 2d 180.

Neither of such situations is present in the instant case. The independent contractors received a stated amount per ton for coal of good merchantable quality satisfactory to petitioner. The amount they were to receive per ton was not dependent upon the market nor upon the price petitioner received upon the sale of such coal. Payment was made at stated intervals provided in the contract and was entirely independent of whether or when petitioner sold the coal. The contractors assumed no risk as to the market price, they received no payment in coal, and they had no right to sell any coal to other parties.

The factors mentioned in the above quotation exist in this case. Summit Fuel was not to receive payment in kind or as a percentage of the selling price or profit; it was to receive a stated price per ton of coal; payment was to be made at stated intervals and was independent of whether or when Gregory Run sold the coal.

The case of James Ruston, 19 T. C. 284, is distinguishable on the facts. In the Ruston case, the lessee of coal property contracted with a strip-mining contractor for the mining, loading, and shipping of the coal. The contractor was granted the sole and exclusive right to use and occupy the leaseholds; the lessee agreed not to engage in any stripping operations on the leaseholds, and not to grant any mining rights to others during the term of the contract. The contractor was to furnish at its cost and expense all materials, tools, machinery, equipment, and labor, to build all necessary roads, to make all necessary improvements incident to its operations, and to maintain and keep in proper repair and working order the tipple, screens, loading ramps, sidings, etc., on the property, and to screen, produce, load, clean, and ship the coal at its own expense. The contractor was also required to carry fire insurance on some of the lessee's property, workmen's compensation on its own employees, and public liability and property damage insurance on the operations. The lessee had the right to sell the coal, but it was provided that the interest of the contractor "in coal produced and shipped shall be 83 per cent of the net selling price" of the coal as received by the lessee, less a selling commission of 15 cents per ton to be deducted from the gross selling price. In actual practice, the selling agent forwarded directly to the stripping contractor its 83 per cent share of the net sales price.

On the facts in the Ruston case, outlined above, we concluded that by the contract between the parties the lessee transferred to the stripping contractor an economic interest in the coal in place which entitled the stripper to percentage depletion on its gross income from the severance and sale of coal. The rights, duties and liabilities of Summit Fuel Company were so far different from those in the Ruston case as to require a different conclusion as to the relation of the stripper with the lessee of the coal lands. We think the relation of Gregory Run Coal Company and Summit Fuel Company was simply that of employer and employee, which gave the employee no more than an economic advantage derived from production rather than an economic interest in the coal.

We conclude that the contract between Gregory Run Coal Company and Summit Fuel Company did not give to Summit Fuel any economic interest in the coal in place. Accordingly, the amounts paid to it by Gregory Run should not be excluded from the latter's gross income from the property.

Inclusion in J. E. Vincent's Income of the Amount of the Note for $ 10,000 Executed by Gregory Run Coal Company, Dated June 12, 1945; Depletion Deduction.

As a part of the deal that was consummated in June 1945, between Vincent and Williamson, Gregory Run Coal Company issued its note to Vincent in the amount of $ 10,000. The note was negotiable and interest bearing. The company paid the note in February 1946.

The petitioner's resistance to inclusion of the face amount of the note in income for 1945 is based primarily on his contention that it had no fair market value at the time he received it. The argument is that Gregory Run Coal Company was engaged in a hazardous business; only $ 1,000 had been paid as capital; its equipment was mortgaged to secure the purchase price, and the payment of Vincent's note was subordinate to the payment of the equipment notes. Both parties make some argument as to the effect of an agreement dated July 9, 1945, between Vincent and Gregory Run Coal Company wherein was set forth the order in which Gregory Run would discharge its obligations. Whatever the effect of that agreement as to Gregory's several creditors thereafter, it is not decisive of the question of the fair market value of Vincent's note at the time he received it on June 12, 1945.

The respondent has included the face amount of the note in income. That action is presumptively correct. The evidence does not establish to our satisfaction that the note had any lesser value. Simultaneously with the issuance of the note, Gregory acquired Vincent's coal leases which presumably both Vincent and Williamson thought were valuable. On one of them a large block of merchantable coal had been uncovered by Vincent. The company had available machinery to do the mining, and it had an agreement for the sale of coal.

We find no error in including the sum of $ 10,000 in Vincent's income for 1945.

The petitioner Vincent contends that if the $ 10,000 note was income for 1945, then he is entitled to a depletion deduction of 5 per cent thereof. His theory is that the amount of the note was a cash bonus in the nature of an advance royalty. He cites Murphy Oil Co. v. Burnet, 287 U.S. 299">287 U.S. 299; Palmer v. Bender, 287 U.S. 551">287 U.S. 551; Sunray Oil Co., 3 T.C. 251">3 T. C. 251, affd., 147 F. 2d 962. The respondent's position is that the note was part of the consideration paid for the transfer of the leases, and that such payments are not subject to deductions for depletion. He cites Helvering v. Elbe Oil Land Development Co., 303 U.S. 372">303 U.S. 372; Anderson v. Helvering, 310 U.S. 404">310 U.S. 404.

We hold that the petitioner is not entitled to the claimed deduction for depletion. The transaction between Vincent and Gregory Run Coal Company was a sale by Vincent of his leases and his marketing agreement. His right to receive payment of the note did not give him an economic interest in the coal in place. The note was secured by a deed of trust upon the properties that he conveyed, and its payment was not made dependent on production of coal. Receipts from sales of mineral properties, not dependent on production, are not subject to deductions for depletion. Anderson v. Helvering, supra; Mertens, Law of Federal Income Taxation, Vol. 4, section 24.23.

Income from Lambert's Run Property, Period May 1, 1947 to December 31, 1947 (Case of J. E. Vincent, Dkt. No. 27878).

The question for decision under this issue is who is to be taxed on the amount of $ 808,064.46 that Vincent turned over to J. E. Vincent, Inc., between May 1, 1947 and December 31, 1947. The respondent disallowed that amount as a deduction to Vincent and thereby treated it as his income. The corporation included in its income the amount in dispute, and its reported income has not been reduced on account thereof by the respondent.

The $ 808,064.46 is, of course, income either to Vincent or Vincent, Inc., but not to both. Both are before us in these proceedings and the issues are so framed as to require us to make the decision.

J. E. Vincent, as an individual, had acquired leases on the Lambert's Run property. He had also, as an individual, negotiated contracts for the stripping of the coal with the two Swaney companies, and for the sale of the coal with the Weaver Company. Vincent wanted to assign the Lambert's Run lease to his controlled corporation but the Dawson Company, the principal lessor, would not consent to the assignment. Vincent so reported to his corporation. Thereupon it became necessary to work out a different arrangement. This was done by the adoption of a resolution by the directors of Vincent, Inc., and the simultaneous execution of an agreement between Vincent and Vincent, Inc. The resolution recited that the corporation would operate the coal properties without assignment of the leases. However, the agreement between Vincent and the corporation, simultaneously entered into, was entirely different. Under the agreement, Vincent, and not the corporation, was to continue to operate the strip-mines in his own name and he was to be regarded as the operator of the coal. It further provided that he was to receive payment from his sales agent for all coal that he had under lease, and that out of the proceeds of such sales he was to pay brokerage, royalties for coal, surface rights, rights of way, rental on sidetrack property and buildings, and other similar royalties, and state taxes on mining operations. The remainder of the sales proceeds, which was described in the contract as "net proceeds" was to be paid over by Vincent to Vincent, Inc., and was so paid in 1947.

Under neither the resolution nor the agreement did Vincent purport to convey to Vincent, Inc., any rights or obligations incidental to the Dawson lease. The Thrasher lease, which granted surface rights, was not mentioned. Neither the stripping contracts nor the contract for the sale of coal were assigned. Apparently Vincent and his corporation decided that if they could not effect a transfer of the underlying Dawson lease, there would be no point in transferring incidental rights and obligations.

The net result of the arrangement between Vincent and Vincent, Inc., was that Vincent paid over to the corporation income earned by him as an operator of coal properties and as an owner of coal leases and other properties in connection therewith. This does not relieve him of tax liability on such income. Lucas v. Earl, 281 U.S. 111">281 U.S. 111; Helvering v. Horst, 311 U.S. 112">311 U.S. 112; Harrison v. Schaffner, 312 U.S. 579">312 U.S. 579.

Even if the agreement between Vincent and Vincent, Inc., can be regarded as vesting in the latter a property right of some kind, nevertheless Vincent's retention of the Dawson lease in his own name, and the retention of other rights and obligations would require the taxation of the income to him. Among the rights that he had was the right of cancelation of the contract on 30 days' notice. Through this he could control the flow of income. Under these facts, the income must be regarded as his. Commissioner v. Sunnen, 333 U.S. 591">333 U.S. 591.

We conclude that the respondent properly included in Vincent's income for 1947 the income that he received in that year from operation of the Lambert's Run property and that he paid over to Vincent, Inc.

As Vincent reported income on the cash basis, the amount of $ 146,823.40 which he collected in January 1948 on account of sales made in December 1947 and paid over to Vincent, Inc., in January 1948 should be included in his income for the year 1948 and excluded from the income of Vincent, Inc., for 1947. There is no dispute between the parties as to amounts to be allowed as expenses in connection with the earning of the above amounts of income from the Lambert's Run property.

Depletion; Gross Income from the Property; Exclusion of Amounts Paid to Strippers (Case of J. E. Vincent for 1947, Vincent, Inc., for Year Ended April 30, 1948 and Period Ended Jan. 3, 1949).

In computing the amounts allowable for depletion in the cases of J. E. Vincent for the year 1947, and of J. E. Vincent Company, Inc., for the year ended April 30, 1948, and the period ended January 3, 1949, the respondent excluded from gross income from the coal properties the amounts paid to the contract strippers, Swaney Contracting Company and B. H. Swaney and Sons, Inc. Such exclusions are assigned as errors by the petitioners.

We have discussed a similar issue as to amounts paid by Gregory Run Coal Company to Summit Fuel Company for stripping coal from other leased properties. Under the contracts with the Swaney companies, as under the Summit Fuel contract, the important feature was that the stripping contractors were employed by the operator to strip-mine coal and haul it to the loading point at a price per ton to be paid by the operator. In Vincent's contracts with the Swaney companies, there were provisions for reduction or increase of the basic price per ton to be paid to the strippers if the current zone market of the price of coal was reduced below or increased above specified amounts per ton. They also contained a provision for cancellation by Vincent if the market price was reduced below a stated figure and if the parties failed to renegotiate the contracts. None of these provisions gave the stripping contractors an economic interest in the coal in place. The sliding price merely provided for adjustment of the price per ton to be paid to the strippers upon the coal that they mined and hauled. The Swaney companies were not dependent on the sale of coal by Vincent for their compensation, as both contracts provided that the failure of the sales agent to pay Vincent should not relieve Vincent of his obligation to pay the Swaneys the price agreed upon at the times and on the basis provided in the agreements. The contracts here were more like those involved in the Morrisdale Coal Co. case, supra, than those in James Ruston, supra.For reasons given above under the issue as to payments by Gregory Run Coal Company to Summit Fuel Company, we hold that this issue is governed by our decision in the Morrisdale Coal case, and that the amounts paid to the stripping contractors should not be excluded from the gross income from the property in computing depletion deductions allowable to J. E. Vincent and J. E. Vincent Company, Inc.

Depreciation Deductions in re Erie Tipple, Scales and Siding (Case of Vincent, Inc., for Year Ended April 30, 1948, and Period Ended Jan. 3, 1949).

In determining the deficiencies in the case of J. E. Vincent Company, Inc., for the fiscal year ended June 30, 1948, and the period ended January 3, 1949, the respondent disallowed portions of the depreciation deductions claimed with respect to the company's Erie tipple, scales and railroad siding. In reducing the depreciation deductions claimed, the respondent explained in the notices of deficiency that the basis for the properties in the hands of Vincent, Inc., was the same as in the hands of its transferor, namely, $ 44,488.03.

The petitioner does not object to the respondent's determination that the salvage value of the properties was $ 20,000, and that the basis was recoverable over a 20-month period. The only issue is the basis.

The tipple and appurtenant properties were acquired by Vincent, Inc., on January 2, 1948, from its controlling stockholder, J. E. Vincent, at a price of $ 125,000 for which amount it gave its check. That amount, on the face of things, was the cost to the petitioner and, in the absence of any recognized exception or unusual circumstance, would be the basis for depreciation. Code section 113 (a); Majestic Securities Corporation, 42 B. T. A. 698, affd. 120 F.2d 12">120 F. 2d 12. The petitioner maintains that the amount paid in this case was the basis. However, it apparently recognizes that transactions between corporations and controlling stockholders may be open to question, Majestic Securities Corporation, supra, and has introduced evidence directed toward establishing that the fair market value of the properties was not less than $ 125,000 at the time of the purchase. That was the testimony of several witnesses who were familiar with the properties and had at least some knowledge of costs of construction and values of tipples and the customary appurtenant properties.

The respondent says that the sale of the properties by Vincent to his controlled corporation was not a bona fide transaction and would not give the corporation a basis of the amount that it paid. He points to Vincent's treatment of the properties in his returns for 1946 and 1947 wherein he reported costs of the properties at $ 54,000 and some $ 61,000, respectively, and claimed depreciation at rates of 33 1/2 per cent on the theory that available coal would be exhausted within three years. We think that those matters are of little importance, particularly in view of the evidence which shows that actual cost to Vincent was in excess of $ 78,000 and that the ownership and operation of the properties were beneficial to the purchaser in the conduct of its business. Also, the petitioner Vincent, in his 1948 return, reported a gain of over $ 88,000 on the sale of the properties.

We conclude that the basis of the properties in the hands of J. E. Vincent Company, Inc., was $ 125,000 and that depreciation deductions should be computed and allowed on that basis.

The parties have stipulated figures to be used in computing allowable depletion deductions in the cases of J. E. Vincent, Docket No. 27878, J. E. Vincent Company, Inc., Docket No. 27879, and Gregory Run Coal Company, Docket No. 27880, after our decision of other issues. Effect will be given thereto in the recomputations.

Decisions will be entered under Rule 50.

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Footnotes

• 1. Proceedings of the following petitioners are consolidated herewith: J. E. Vincent, Docket No. 27878; J. E. Vincent Company, Inc., Docket No. 27879; Gregory Run Coal Company, Docket No. 27880; and J. E. Vincent Company, Inc., Docket No. 30435.↩

• 2. The rate under the Swaney Company contract was $ 2 per ton. Finding No. 38.↩

• 3. In determining the deficiency in the case of J. E. Vincent for the calendar year 1947, the Commissioner treated as an "unallowable deduction" the $ 808,064.46 that Vincent paid to Vincent, Inc., and he allowed as "additional deductions" the amount of $ 565,743.67 that Vincent, Inc., had paid as expenses in the period ended December 31, 1947. The Commissioner did not make corresponding adjustments in the income and deductions of Vincent, Inc.↩

• 4. West Virginia Code, Mining Laws, chapter 22, article 2A.↩