Mr. Justice Clark
delivered the opinion of the Court.
The issue in these consolidated tax cases is whether the lessee of coal lands is entitled to percentage depletion on all the gross income derived from the sale of the coal mined from its leases, or whether contract miners who do the actual mining acquired a depletable interest within the meaning of § 611 and 613 (b) (4) of the Internal Revenue Code of 1954 to the extent they were paid by the lessee for mining and delivering coal to it.
The mining contractors, respondents in No. 237, claimed an allocable portion of the allowance for the years 1954 through 1956, while the lessee, petitioner in No. 134, claimed the right to the entire depletion deduction for 1955 through 1957. In each case the deduction was denied the taxpayer. However, the Commissioner now takes the position that the lessee is entitled to the entire allowance; the Tax Court so held, 39 T. C. 257, but the Court of Appeals agreed with the contractors. 330 F. 2d 161. We granted certiorari in No. 134, 379 U. S. 812, and in No. 237, 379 U. S. 886, and consolidated them for argument. We have concluded that the Tax Court was correct and reverse the judgment of the Court of Appeals.
The parties agree that the principles of our opinion in Parsons v. Smith, 359 U. S. 215 (1959), are controlling here. There we held that the deduction is allowed in recognition of the fact that mineral deposits are wasting assets and that the deduction is intended as compensation to the owner for the part used in production ; that there may be more than one depletable interest in the same coal deposit, but that the right to an allocable portion of the allowance depends on the ownership of an economic interest in the coal in place since the statute makes the deduction available only to the owner of a capital interest in such deposit; and, finally, that the legal form of such capital interest is unimportant so long as it constitutes a right with regard to the coal in place.
The problem arises in applying those principles "according to the peculiar conditions in each case." The mining contractors contend that they made a capital investment in the coal in place because of the nature and extent of their expenditures in preparation for and in the performance of oral agreements which they claim granted them the right to mine certain designated areas to exhaustion. They contend that they could only look to the extraction and sale of coal for a return of their investment, and thus that the test of Parsons v. Smith, supra, is satisfied.
Paragon, on the other hand, says that Congress never intended for contractors mining coal to have a depletable interest as evidenced by statutory enactments adopted subsequent to the tax years involved in Parsons v. Smith, supra; that in the case of a lease the lessor of coal lands is no longer granted a deduction for depletion but is relegated to capital gains treatment only. And, finally, that the expenditures made by the contractors were only for equipment which they depreciated and could not constitute an investment in the coal in place as required under Parsons v. Smith, supra.
The Commissioner of Internal Revenue takes the position that only a taxpayer with a legally enforceable right to share in the value of a mineral deposit has a depletable capital or economic interest in that deposit and the contract miners in this case had no such interest in the unmined coal.
The Facts.
Paragon took an assignment of written leases on the coal in and under certain lands which obligated it to pay annual minimum cash royalties, tonnage royalties, land taxes, and to mine all or 85% of the minable coal in the tracts. It made substantial investments in preparation for processing and marketing the coal, including construction of a tipple, a power line, a railroad siding with four spurs and the purchase of processing equipment. It also built a road from the tipple which circled the mountain close to the outcrop line of coal. This road was used to truck the coal from the contractors' mines to Paragon's tipple.
Paragon made oral agreements with various individuals and firms to mine the coal in allocated areas under its leases. They were to mine the coal at their own expense and deliver it to Paragon's tipple at a fixed fee per ton for mining, less 2%% for rejects. It was understood that this fee might vary from time to time — and it did so— depending somewhat on the general trend of the market price for the coal over extended periods and to some extent on labor costs. However, any changes in the fixed fee were always prospective, the contractors being notified several days in advance of any change so that they always knew the amount they would get for the mining of the coal upon delivery. After delivery to Paragon's tipple the contractor had no further control over the coal, and no responsibility for its sale or in fixing its price. The fixed fee was earned and payable upon delivery and the contractors did not even know the price at which Paragon sold.
The contractors agreed to buy power at a fixed rate per ton from Paragon's line or put in their own diesel engine generator and compressors. A certain amount per ton was also paid by the contractors for engineering services inside the mine. An engineer provided by Paragon was used to map out or show each of the contractors the particular direction his mine was to take, the locations of adjacent mines, etc. The single engineer was utilized for all of the mines to ensure that they would not run into each other and also so that no minable coal would be rendered unrecoverable by haphazard mining methods. Periodically, the engineer would extend his projections of the mine in order to keep it within the contractor's original location.
Because of the nature of the coal deposits, it was necessary to use the drift-mining method which requires the opening of two parallel tunnels, one for ventilation and the other for working space and removal of coal. In this type operation the roof is supported by leaving pillars of coal in place and erecting wooden supports about every 18 inches. However, as the miners withdraw from a mine where the coal seam has been exhausted, they take out the wooden supports and also remove the coal pillars, thus recovering the last bit of minable coal. Because of the method used it often takes six to eight weeks to develop a mine to the point where it can be operated profitably.
The nature of the coal deposits here involved was such that the miners often encountered "a sandstone roll" which is an outcrop of rock which "squeezes" out the coal. When one of these situations is encountered the miners must move large amounts of rock to reach the coal seam. During this period, of course, they are receiving no money because they are not delivering merchantable coal to Paragon's tipple. At other times, water might accumulate which would have to be pumped out before work could resume. Again, the contract miners received nothing for this clearing operation.
After the coal was removed it was placed in the contractor's bins at the entrance to the mine and was later trucked over a connecting roadway built by the contractor to the adjacent road of Paragon and then taken to the latter's tipple. Paragon took all of the merchantable coal mined. If its facilities were full at the moment the contractor would fill his own bins and then shut down his mine. The record shows no deliveries by the contractors to anyone other than Paragon.
Although there was nothing said at the time of the oral contracts regarding who was to receive the depletion, the Tax Court found that Paragon expected to receive that deduction and had fixed its per-ton fee for mining with this in mind. The contracts were also silent regarding termination and were apparently for an indefinite period. However, numerous contractors quit mining, and some sold their equipment, buildings, tracks, etc., to others. Under the agreements, those ceasing to operate could not remove the buildings, but could remove all other equipment. It was anticipated that the contractors would continue mining in their allocated areas as long as it was profitable and so long as proper mining methods were used and the coal met Paragon's standards. However, the contractors were under no obligation to mine any specific amount of coal and were not specifically given the right to mine any particular area to exhaustion.
The contractors paid nothing for the privilege of mining the coal; they acquired no title to the coal either in place or after it was mined; they paid none of the royalty or land taxes required by Paragon's leases; they claim no sublease, no co-adventure, no partnership. Their sole claim to any interest in the coal in place is based on their investment in equipment, connecting roadways, buildings and the costs of opening the mine, and, in some in stances, on their installation of track inside the mine to remove the coal. They admit, however, that all of this was removable, save the buildings and the connecting roadways, neither of which represented any appreciable expenditure. All of their expenditures were deducted either as direct costs, development costs, depreciation of equipment or capital assets.
On the basis of these facts the Tax Court concluded as a matter of law that the contractors did not have a de-pletable interest under their contracts. The Court of Appeals accepted all of the Tax Court's findings but held that the latter erred in its conclusions. It reversed on the basis that the contractors were "performing Paragon's obligation under its leases and this constituted ample consideration" together with their "continuing right to produce the coal and to be paid therefor at a price which was closely related to the market price" to give them "an economic interest in the mineral [bringing] them within the rationale of Parsons v. Smith . . . ." At 163. We believe that the Court of Appeals was in error in so doing.
Statutory Provisions for Coal Depletion.
This Court has often said that the purpose of the allowance for depletion is to compensate the owner of wasting mineral assets for the part exhausted in production, so that when the minerals are gone, the owner's capital and his capital assets remain unimpaired. United States v. Cannelton Sewer Pipe Co., 364 U. S. 76, 81 (1960). Percentage depletion first came into the tax structure in 1926 and has been consistently regarded as a matter of legislative grace. We, therefore, must look to the Code provisions and regulations in effect during the years involved to determine whether these contract coal miners acquired a depletable interest in the coal in place.
Section 611 (a) provides for "a reasonable allowance for depletion . . . according to the peculiar conditions in each case; such reasonable allowance in all cases to be made under regulations prescribed by the Secretary . . . The pertinent regulation states:
"(1) Annual depletion deductions are allowed only to the owner of an economic interest in mineral deposits or standing timber. An economic interest is possessed in every case in which the taxpayer has acquired by investment any interest in mineral in place or standing timber and secures, by any form of legal relationship, income derived from the extraction of the mineral or severance of the timber, to which he must look for a return of his capital. But a person who has no capital investment in the mineral deposit or standing timber does not possess an economic interest merely because through a contractual relation he possess [es] a mere economic or pecuniary advantage derived from production. For example, an agreement between the owner of an economic interest and another entitling the latter to purchase or process the product upon production or entitling the latter to compensation for extraction or cutting does not convey a depletable economic interest. . . ." Treas. Reg. § 1.611-1 (b)(1).
Section 611 (b) establishes an equitable apportionment of such allowance between the lessor and the lessee in the case of a lease. However, § 611 (b) must now be read in light of § 631 (c) which provides that an owner who disposes of coal under any form of contract in which he retains an economic interest shall not receive percentage depletion, but instead must take capital gains treatment for the royalties received under that contract. The result of this in the typical lessor-lessee situation is that the lessee is entitled to the entire depletion allowance on the gross income from the property. Respondent contract miners make no contention that they are lessees or the sublessees of Paragon.
However, they claim that they are entitled to a portion of the percentage depletion because they have somehow acquired an economic interest in the coal in place. This test was first enunciated in Palmer v. Bender, 287 U. S. 551, 557 (1933), and has since become the touchstone of decisions determining the eligibility of a party to share in the depletion allowance. The contract miners contend that their investments of time and money in developing these mines bring them within the meaning of our cases. We believe that Parsons v. Smith, supra, completely settles this question against them.
In Parsons, the Court enumerated seven factors to be considered in determining whether the coal-mining contracts there involved gave the contract miners any capital investment or economic interest in the coal in place. They were:
"(1) that [the contract miners'] investments were in their equipment, all of which was movable — not in the coal in place; (2) that their investments in equipment were recoverable through depreciation— not depletion; (3) that the contracts were completely terminable without cause on short notice; (4) that the landowners did not agree to surrender and did not actually surrender to [the contract miners] any capital interest in the coal in place; (5) that the coal at all times, even after it was mined, belonged entirely to the landowners, and that [the contract miners] could not sell or keep any of it but were required to deliver all that they mined to the landowners; (6) that [the contract miners] wer'e not to have any part of the proceeds of the sale of the coal, but, on the contrary, they were to be paid a fixed sum for each ton mined and delivered . . . ; and (7) that [the contract miners], thus, agreed to look only to the landowners for all sums to become due them under their contracts." At 225.
The Tax Court found all of these factors present in this case and ruled therefore that Parsons controlled.
The Court of Appeals agreed with the contractors' position and held, contrary to the Tax Court, that the contracts under which they mined the coal were not terminable at the will of Paragon but gave the contractors "a continuing right to produce the coal and to be paid therefor at a price which was closely related to the market price." It based its decision on the fact that the operators made "large expenditures of time and money in preparing their respective sites for mining" and that "[i]t would be inequitable indeed to hold that Paragon might . . . then take the benefit of tfie operators' efforts at will and without cause." At 163. We regret that we are unable to agree.
In Parsons the contract was expressly terminable on short notice; here no specific right to terminate was mentioned in the agreement between the parties. However, as the Court of Appeals noted, "the contracts did not fix upon the operators an obligation to mine to exhaustion." In fact, many of them quit at any time they chose. We are unable to say that it is any more inequitable to allow Paragon to terminate the contracts at will than it is to allow the contractors to terminate work and thereby impose upon Paragon the obligation to get other people to work the mine or forfeit its right under the leases.
In any event, the right to mine even to exhaustion, without more, does not constitute an economic interest under Parsons, but is "a mere economic advantage derived from production, through a contractual relation to the owner, by one who has no- capital investment in the mineral deposit." Helvering v. Bankline Oil Co., 303 U. S. 362, 367 (1938).
The court below also indicated that it disagreed with the conclusion of the Tax Court that Paragon could set the price at any level it chose under the agreements. It stated that the contractors were "to be paid therefor at a price which was closely related to the market price." The conclusion of the Tax Court was that while the fee varied somewhat with labor costs, "there [was] no evidence that the amount paid by Paragon was directly related either to the price it was getting for the coal or to the sales price of a particular contractor's coal, and the amount was apparently changeable at the will of Paragon." (Emphasis supplied.) 39 T. C., at 282. After an examination of the entire record, we can only conclude that Paragon at all times retained the right to change its fixed fee at will, and after delivery to the tipple, the contractors could only rely on Paragon's personal covenant to pay the posted price. This is insufficient. As we said in Palmer v. Bender, 287 U. S. 551, 557 (1933), the deduction is allowed only to one who "has acquired, by investment, any interest in the oil in place, and secures, by any form of legal relationship, income derived from the extraction of the oil, to which he must look for a return of his capital." (Emphasis supplied.) Here, Paragon was bound to pay the posted fee regardless of the condition of the market at the time of the particular delivery and thus the contract miners did not look to the sale of the coal for a return of their investment, but looked solely to Paragon to abide by its covenant.
This construction of the Act as to coal depletion is buttressed by the language of the Treasury Regulations which, by example, specifically provide that "an agreement between the owner of an economic interest and another entitling the latter to . . . compensation for ex traction . . . does not convey a depletable economic interest." This language was taken almost verbatim from Helvering v. Bankline Oil Co., 303 U. S. 362, 367 (1938), and incorporated in the first regulations under the Internal Revenue Code of 1939, and since that time there have been no major changes in the economic-interest-versus-economic-advantage paragraph. Compare Treas. Reg. 103, §19.23(m)-1; Treas. Reg. 111, §29.23(m)-1; and Treas. Reg. 118, § 39.23 (m)-1 (a)-(b), with Treas. Reg. § 1.611-1 (b)(1). This Regulation has survived through successive amendments of the Internal Revenue Code and therefore is entitled to great weight.
Further, we believe that additional support is given to our construction by subsequent statutory enactments. As noted above, an owner who by contract disposes of the coal in place while retaining an economic interest is relegated to capital gains treatment of the royalties received. However, exemptive language in § 631 (c) excludes an owner who is also a co-adventurer, partner or principal in the mining of coal, thus permitting such an owner to secure percentage depletion. "Owner" is defined for purposes of this subsection as "any person who owns an economic interest in coal in place, including a sublessor." (Emphasis supplied.) While Paragon is certainly an owner of an economic interest in the coal, it is also a principal in the mining of coal and thus comes within the exemption and is expressly allowed depletion. The contract miners do not claim, nor will the record support a contention, that they are a "co-adventurer, partner, or principal." In contrast to the language of § 631 (c), it is noted that in treating with timber in § 631 (b) an "owner" is allowed capital gains instead of depletion. In this instance "owner" is defined to be "any person who owns an interest in such timber, including a sublessor and a holder of a contract to cut timber." (Emphasis supplied.) This last phrase as to contractors is not included in § 631 (c) thus indicating that as to coal, "owner" does not include contract coal miners. Clearly the Congress knew what language to use when it wished to give a contractor a tax allowance. It gave holders of contracts to cut timber capital gains treatment in § 631 (b) but did not so provide for contract coal miners in § 631 (c).
Nor does the opinion in Commissioner v. Southwest Exploration Co., 350 U. S. 308 (1956), undercut our conclusion. There the State of California required that the State's offshore oil might be extracted only from wells drilled on filled lands or slant drilled from upland drill sites to the submerged oil deposits. Pursuant to that statute Southwest entered into an agreement with upland owners whereby in the event it was awarded a lease by the State it was given the right to use the surface of the upland as a base for its derrick and drilling operation in reaching the leased oil premises. In consideration of this use Southwest assigned to the upland owners, 24%% of the net profits derived from the oil recovered. This agreement was the sine qua non of Southwest's securing a lease to drill the submerged land from the State. We held that Southwest's right to drill being expressly conditioned by law upon the agreements with the upland owners made the latter essential parties to the lease from the State and was a sufficient investment by them in the obtaining of the lease to give them an economic interest in the oil in place, which investment was recoverable solely through the extraction of the oil to which they had to look for the return of their investment. Here we have no such statute; the contractors had no part whatever in the lease but were wholly disassociated from it; no fixed percentage of the net income from Paragon's lease was assigned to the contractors; and the latter did not look to the coal but to Paragon for their payment.
For these reasons the judgment is reversed.
It is so ordered.
Paragon Jewel Coal Co. was actually an assignee or sublessee of the coal lands in this particular case. However, this is a factual matter without significance here, and for purposes of convenience it will be referred to as the lessee throughout the opinion.
The Commissioner took a neutral position in the Tax Court, but contended before the Court of Appeals, as he does here, that the lessee is entitled to the depletion deduction on all the gross income derived from the sale of coal mined from its leases.
I. R. C. 1954, § 611, 26 U. S. C. § 611 (1958 ed.).
I. R. C. 1954, §631 (c), 26 U. S. C. §631 (c) (1958 ed.).
Drift mining is an underground mining operation in which a horizontal coal seam is reached by clearing away a part of the mountainside with a bulldozer. Two openings are made into the coal seam. One is an entry and the other is an air course used to ventilate the mine. Coal is removed as the drift mine is driven into the mountain following the seam of coal.
This shoring up prevents cave-ins and like all safety requirements, both state and federal, was done at the miners' expense.
Paragon on at least one occasion shared in the cost incident to going through a sandstone roll of unusual proportions, but that was apparently not the practice.
Parsons v. Smith, 359 U. S. 215, and cases cited in n. 5, at 219.
For the text of § 631 (c) see n. 10, infra.
Section 631 (c) for the pertinent period read:
"In the case of the disposal of coal (including lignite), held for more than 6 months before such disposal, by the owner thereof under any form of contract by virtue of which such owner retains an economic interest in such coal, the difference between the amount realized from the disposal of such coal and the adjusted depletion basis thereof plus the deductions disallowed for the taxable year under section 272 shall be considered as though it were a gain or loss, as the case may be, on the sale of such coal. Such owner shall not be entitled to the allowance for percentage depletion provided in section 613 with respect to such coal. This subsection shall not apply to income realized by any owner as a co-adventurer, partner, or principal in the mining of such coal, and the word 'owner' means any person who owns an economic interest in coal in place, including a sublessor. The date of disposal of such coal shall be deemed to be the date such coal is mined. In determining the gross income, the adjusted gross income, or the taxable income of the lessee, the deductions allowable with respect to rents and royalties shall be determined without regard to the provisions of this subsection. This subsection shall have no application, for purposes of applying subchapter G, relating to corporations used to avoid income tax on shareholders (including the determinations of the amount of the deductions under section 535 (b)(6) or section 545 (b)(5))." (Emphasis supplied.) It is interesting to note that when § 631 (c) was amended in 1964 to include domestic iron ore Congress did not change the language of this section to also include those mining such ore or coal under a contract since it had made provision for such contractors in § 631 (b) dealing with timber.
We said in Commissioner v. Southwest Exploration Co., supra, at 317:
"We decide only that where, in the circumstances of this case, a party essential to the drilling for and extraction of oil has made an indispensable contribution of the use of real property adjacent to the oil deposits in return for a share in the net profits from the production of oil, that party has an economic interest which entitles him to depletion on the income thus received."