Engle v. Commissioner

76 T.C. 915, 1981 U.S. Tax Ct. LEXIS 116, 69 Oil & Gas Rep. 375

• Court: United States Tax Court
• Decided: June 8, 1981
• Docket: Docket No. 6219-79
• Status: Published

Opinions

OPINION

Featherston, Judge:

Respondent determined a deficiency in the amount of $4,957.65 in petitioners’ Federal income tax for 1975. Petitioners failed to take exception to certain items of adjustment; therefore, the only issue for decision is whether a percentage depletion deduction is allowable under section 613A¹ with respect to $7,600 that petitioners received in 1975, as advance royalties, under the terms of their assignment of two oil and gas leases.

All of the facts have been stipulated.

At the time the petition was filed, petitioners, who are husband and wife, were legal residents of Hartland, Wis. They filed their joint Federal income tax return for 1975 with the Internal Revenue Service Center, Kansas City, Mo.

Effective July 1, 1975, petitioner Fred L. Engle (Fred) procured an oil and gas lease covering 80 acres of land in Campbell County, Wyo. On October 6,1975, he assigned the lease to Getty Oil Co., retaining, however, a 5-percent overriding royalty.² As part of the consideration for the assignment, he received an advance royalty in the amount of $6,000.

Fred was also the lessee under an oil and gas lease, effective beginning September 2, 1975, covering 160 acres of land in Carbon County, Wyo. On October 22,1975, petitioners assigned this lease to Marshall & Winston, Inc.,³ retaining a 4-percent overriding royalty. As part of the consideration for the assignment, they received an advance royalty in the amount of $1,600.

The amounts received as consideration for the assignments of the leases constituted the only taxable income from the described properties in 1975. There were no related expenses. Prior to the end of 1975, no discovery or exploratory work had be m done on the properties covered by the leases, and no oil or gas had been produced from the properties. During 1975, petitioners had no average daily production of domestic crude oil or natural gas and no average daily secondary or tertiary production of domestic crude oil or natural gas, within the meaning of section 613A(c), quoted in note 8 infra, which provides a limited deduction for percentage depletion in the case of oil and gas wells.

Section 611(a) provides in part that, in the case of mineral deposits (including oil and gas wells), “there shall be allowed as a deduction in computing taxable income a reasonable allowance for depletion.” In theory, this deduction is allowed in order to permit the holder of an “economic interest” in minerals in place to recover his capital investment in those minerals tax free.⁴ See sec. 1.611-1(b)(1), Income Tax Regs.; Kirby Petroleum Co. v. Commissioner, 326 U.S. 599, 602-603 (1946); Palmer v. Bender, 287 U.S. 551, 557-558 (1933). For purposes of computing the deduction, Congress has provided two different methods, cost depletion⁵ and percentage depletion,⁶ and, where a taxpayer is entitled to use either method, the method allowing the greater deduction for any given tax year must be used to compute depletion for that year. Secs. 1.611-l(a), 1.613-1, Income Tax Regs.

Prior to 1975, it was well settled that the recipient of advance royalties (i.e., royalties paid in advance of the actual production of a mineral) under an oil and gas lease was entitled to compute depletion on the basis of both the cost method and the percentage method and to deduct the greater of the two amounts so computed. See, e.g., Herring v. Commissioner, 293 U.S. 322 (1934). Effective for taxable years beginning after December 31, 1974, however, the Tax Reduction Act of 1975 added a new section, section 613A, and related provisions which, with certain exceptions, generally eliminated percentage depletion in the case of oil and gas wells.⁷ One of the exceptions, on which petitioners rely, provides a limited exemption for independent producers and royalty owners. Sec. 613A(c).⁸ Under this exception, the deduction of percentage depletion continues to be permitted “with respect to * * * so much of the taxpayer’s average daily production of domestic crude oil or natural gas as does not exceed the taxpayer’s “depletable quantities” of crude oil and natural gas.

A taxpayer’s “average daily production” of domestic crude oil or natural gas is determined by dividing his aggregate production⁹ during the taxable year by the number of days in such taxable year. Sec. 613A(c)(2)(A). Under section 613A(c)(3), the taxpayer’s depletable oil quantity is equivalent to a specified “tentative quantity,” stated in terms of a certain number of barrels of oil “production during the calendar year,” reduced by the taxpayer’s average daily secondary or tertiary production of domestic crude oil and natural gas¹⁰ for the “taxable year.”¹¹ The taxpayer’s depletable natural gas quantity is equal to the number of barrels of his depletable oil quantity that he elects to convert to depletable natural gas quantity,¹² and the taxpayer’s depletable oil quantity is reduced by the number of barrels for which he has made such an election.¹³

The number of barrels constituting the taxpayer’s tentative depletable oil quantity is set forth in a “Phase-out table” in section 613A(c)(3)(B). The number of barrels in this table is gradually reduced in the case of “production during the calendar year” from 2,000 barrels in 1975 to 1,000 barrels in 1980 and thereafter. In this connection, section 613A(c)(5) sets forth a table of percentages that are applicable in computing the percentage depletion allowance in the case of “production during the calendar year.” The percentage to be used gradually declines from 22 percent in 1975 to 15 percent in 1984 and thereafter.

Respondent, in this case and in proposed regulations under section 613A(c), has taken the position that the exemption for independent producers and royalty owners does not allow percentage depletion on advance royalties paid under an oil and gas lease except to the extent that they are earned or “recouped” through actual production of oil or gas during the taxable year in which the advance royalties are received.¹⁴ In support of his position, respondent emphasizes the language in section 613A(c)(l) stating that the allowance for depletion under section 611 shall be computed in accordance with section 613 only “with respect to * * * so much of the taxpayer’s average daily production” of domestic crude oil or natural gas as does not exceed the depletable oil and natural gas quantities specified in section 613A(c)(3) and (4). Respondent reasons that petitioners, having no “average daily production” of oil or natural gas for 1975, have nothing with respect to which percentage depletion may be computed in accordance with section 613.

Petitioners, on the other hand, emphasize that percentage depletion was allowable with respect to advance royalties prior to the enactment of section 613A, notwithstanding the absence of production of oil or gas during the year of receipt of such payments. They point out that the depletion allowance has always been “based on the proceeds derived from the property” and argue that, therefore, “no quantity of oil or gas is required for purposes of the calculation.” Petitioners contend that the quantities of production specified in section 613A(c) were simply intended to limit the applicability of the exemption for independent producers and royalty owners to those producers and royalty owners with production levels below the ceiling quantities and that prior law was to be retained in full with respect to that class of persons.¹⁵ Thus, petitioners maintain that “zero [production] is within the limitation just as is one drop of oil or one cubic centimeter of natural gas” and that, therefore, they are entitled to compute percentage depletion on the advance royalties in 1975.

We hold that petitioners are not entitled to deduct in 1975, a year in which they had no production of oil or gas, percentage depletion computed with reference to their $7,600 in advance royalties. Petitioners may deduct only cost depletion with respect to that sum, and they have made no claim to such a deduction.

As petitioners point out, the amount of the percentage depletion allowance under section 613(a) was computed prior to the enactment of section 613A(c) on the basis of the “gross income from the property,” without regard to quantities of production. Nevertheless, section 613A(c) now imposes limitations on the percentage depletion allowance in terms of quantities of production and, as we read it, permits the computation of percentage depletion only with respect to gross income attributable to what might be called an exempt quantity of crude oil or natural gas production. Therefore, unless gross income can be identified as attributable to an exempt quantity of production (which, of course, can hardly be done in the case of payments received in advance of production), the computation of percentage depletion is not permitted.

In our view, the express language of section 613A(c) limiting the percentage depletion deduction to stated quantities of production is so clear that it permits no other reasonable interpretation. Section 613A(c)(l) allows percentage depletion only with respect to a limited amount of the taxpayer’s “average daily production.” As previously noted, the taxpayer’s “average daily production” is to be determined by dividing his aggregate production by the number of days in “the taxable year”; if there has been no aggregate production, there can be no “average daily production,” and percentage depletion is not, therefore, allowable.

Further support for this conclusion is found in the table in section 613A(c) specifying the tentative number of barrels in a taxpayer’s “depletable oil quantity” (to which the “depletable natural gas quantity” is keyed) and in the table specifying the declining applicable percentage to be used in computing the percentage depletion deduction. Both tables refer to “production during the calendar year.” Sec. 613A(c)(3) and (5). Given this statutory language, we think it clear that percentage depletion is allowable under section 613A(c) in a taxable year only if oil or natural gas has been produced, and the amount of the deduction must be computed by reference to the taxpayer’s “average daily production,” the depletable oil and natural gas quantities, and the applicable rates set forth in section 613A(c)(5) for the calendar year of production.¹⁶ Because petitioners had no “average daily production” in 1975, they are not entitled to percentage depletion with respect to the advance royalties of $7,600 received in that year.

Petitioners’ position that section 613A(c) retains prior law for independent producers and royalty owners, “so long as the quantities applicable to the exemption are not exceeded,” is without merit. Section 613A(c) does not impose a production ceiling for the purpose of distinguishing a class of taxpayers entitled to the benefits of the exemption from those who are not. Independent producers and royalty owners having average daily production in excess of the statutorily prescribed depletable oil or natural gas quantities are entitled to use percentage depletion. The effective rate per unit of oil or gas is modified for those who have production in excess of their depletable quantities,¹⁷ see sec. 613A(c)(7);¹⁸ but independent producers and royalty owners are not denied percentage depletion deductions merely because they have oil or gas production in excess of the depletable quantities. Only those persons who are “retailers” or “refiners” (or persons related to “retailers” or “refiners”), as those terms are defined in section 613A(d), are excluded from the class of taxpayers entitled to the benefits of the exemption.

Nor does the language in the Conference Committee report, quoted in note 15 supra, to the effect that the Senate version of the bill “retains percentage depletion” for the small independent producer, aid petitioners’ cause. That language was clearly intended to refer to the fact that, under the Senate version, the 22-percent rate for percentage depletion was to be retained on a permanent basis in connection with the exemption for independent producers. It was not the Senate version of the bill, but a Conference substitute, that was enacted into law. The Conference report makes it plain that, although the Conference substitute followed the Senate version by providing a limited exemption for independent producers,¹⁹ the exemption was to be gradually phased down both in terms of the exempt quantity of production and the rate to be applied in computing percentage depletion. Conf. Rept 94-120 (1975), 1975-1 C.B. 624, 630. The Conference report does not, as petitioners urge, indicate that prior law was to be retained in full for a certain class of producers and royalty owners.²⁰

Section 613A(c)(l) does state, however, that “the allowance for depletion under section 611 shall be computed in accordance with section 613 [emphasis added]” with respect to so much of the taxpayer’s average daily production of oil or gas as does not exceed his depletable quantities. Section 613(a)²¹ provides that, in computing percentage depletion, the measure of the deduction is a specified percentage of the “gross income from the property.” Further, section 613(a) provides that the allowance shall not exceed 50 percent of “the taxpayer’s taxable income from the property (computed without allowance for depletion).”

A large body of law has developed under section 613(a) as to the meaning of “gross income from the property” in relation to oil and gas wells. Extensive regulations have been issued to define the phrase “taxable income from the property” as used in section 613.²² That section, its predecessors, and the regulations have been the subject of numerous Revenue Rulings and court opinions on how the “gross income from the property” and “taxable income from the property” are to be computed.²³ We think the language in section 613A(c) to the effect that the percentage depletion allowed to independent producers and royalty owners “shall be computed in accordance with section 613” means simply that the computation is to follow the principles already developed for computing percentage depletion for oil and gas, subject, of course, to the provisions of section 613A. Thus, percentage depletion under section 613A(c) is to be computed with reference to the “gross income from the property” attributable to the exempt portion of a taxpayer’s “average daily production,” but the allowance is limited to 50 percent of the “taxable income from the property.”

It is true that, as petitioners emphasize, the Supreme Court in Herring v. Commissioner, 293 U.S. 322, 328 (1934), rejected the contention that some production of oil or gas was a prerequisite to the allowance of percentage depletion on a lease bonus or advance royalty received upon the execution of an oil and gas lease. The basis for this holding was that bonuses and advance royalties are not capital gains but “payment[s] in advance for oil or gas to be extracted, and * * * [are] therefore taxable income.” Herring v. Commissioner, supra at 324. However, the statute there involved (the predecessor of sec. 613) made “gross income from the property,” without qualification, the base for computing percentage depletion.²⁴ The Court did not have before it the subsequently enacted provisions of section 613A(c) allowing percentage depletion, as we have discussed above, only with respect to the exempt portion of a taxpayer’s average daily production of crude oil or natural gas. Under section 613A(c), where there has been no production during the taxable year of receipt, percentage depletion is not allowable in that year with respect to advance royalties paid under an oil and gas lease.

Of course, actual production of oil or gas at some point in time has always been an implicit requirement of the allowance for depletion under either the cost or the percentage method.²⁵ However, we do not think, as petitioners appear to contend, that income from possible production in a future year will suffice for the purposes of section 613A(c). In effect, this would mean that “production” as used in section 613A(c) should be read to mean “sales of future production.”²⁶ There is no legislative history or discernible legislative purpose that will support such a rewriting of the statutory language.

Section 613A(c) does not refer merely to production in general, but to a taxpayer’s aggregate production “during the taxable year.” In prescribing the depletable quantities, the section specifies a quantity of oil measured in “barrels” of “production during the calendar year” and a quantity of natural gas measured by reference to “barrels” of oil and “cubic feet” of gas. The section also makes important distinctions that depend on the type of production, i.e., oil versus natural gas, and the method of production, i.e., primary versus secondary or tertiary. Sec. 613A(c)(6) and (7). It is difficult to conceive what language Congress could have chosen to state more clearly a requirement tying the allowance of percentage depletion to the actual production of oil or gas on an annual basis.

Finally, numerous practical problems would arise in the application of section 613A(c) if production were interpreted to include royalties received in advance of production. When advance royalties are received upon the execution or assignment of a lease, the lessor may not know what mineral will be discovered or (in some cases) what method of recovery will be required to produce it. As pointed out above, the section prescribes different formulae for computing a taxpayer’s “de-pletable oil quantity” and a taxpayer’s “depletable natural gas quantity.” Section 613A(c)(6) prescribes an entirely separate set of rules with respect to the allowance of percentage depletion on secondary and tertiary production. If a taxpayer has “excess production” during the taxable year, he must allocate the taxable income from the property between oil and gas production. Sec. 613A(c)(7). It should also be noted that section 613A(b)(2), as amended by the Energy Tax Act of 1978,²⁷ allows percentage depletion at the rate of 10 percent with respect to “any qualified natural gas from geopressured brine.” Thus, if the term “production” as used in section 613A(c) is read so as to include income from the production of future years, there may be no way to determine at the time such income is received whether the section 613A(b) and (c) limitations on oil or gas and on primary or (in some situations) secondary production, or natural gas from geopressured brine, would apply.

In our view, the fact that section 613A(c) was written into the Internal Revenue Code as a limited exception to the general repeal of percentage depletion for oil and gas militates against giving that section an expansive and extraordinary interpretation. Given the language of the statute and the absence of any legislative history indicating that the statute does not mean what it says, percentage depletion may not be deducted except with respect to exempt quantities of production. In the case of royalties paid in advance of production, the statutes here applicable limit the taxpayer to a deduction for cost depletion.

To reflect the foregoing,

Decision will be entered for the respondent,²⁸

Reviewed by the Court.

Nims, J., did not participate in the consideration or disposition of this case.

1 All section references are to the Internal Revenue Code of 1954, as in effect during the tax year in issue, unless otherwise noted.

2 The term “royalty,” as used in the area of natural resources taxation, refers to a fractional interest in the “production” (i.e., extraction) of oil and gas or other minerals that is created by the owner (in fee) of the minerals. F. Burke & R. Bowhay, Income Taxation of Natural Resources, sec. 2.03 (1980); 1 L. Fiske, Federal Taxation of Oil & Gas Transactions, see. 2.08 (1980 rev.).

As stated in Income Taxation of Natural Resources, supra at sec. 2.05:

“An overriding royalty is similar to a royalty in that, for Federal tax purposes, each is a right to minerals in place that entitles its owner to a specified fraction of production, in kind or in value, and neither is burdened with the costs of development or operation. They differ in that an overriding royalty is created from the operating interest, and its term is co-extensive with that of the operating interest from which it was created.

“The overriding royalty may be carved out or retained. It is said to be carved out if the owner of the working interest assigns a right to a fractional share of production free and clear of development and operating expense. It is retained if the lessee assigns the working interest and retains a fractional share of production free of development and operating costs.”

For convenience, we shall herein use the term royalty in a more general sense in referring to the advances that petitioners received on overriding royalties.

3 Although only Fred had signed the lease as lessee, both petitioners executed the assignment to Marshall & Winston, Inc.

4 In practice, a taxpayer may be able to recover his investment several times over due to the allowance of percentage depletion, under secs. 613 and 613A, which will be discussed infra.

5 SEC. 612. BASIS FOR COST DEPLETION.

Except as otherwise provided in this subchapter, the basis on which depletion is to be allowed in respect of any property shall be the adjusted basis provided in section 1011 for the purpose of determining the gain upon the sale or other disposition of such property.

See sec. 1.611-2(a), Income Tax Regs.

6 SEC. 613. PERCENTAGE DEPLETION.

(a) General Rule. — In the case of the mines, wells, and other natural deposits listed in subsection (b), the allowance for depletion under section 611 shall be the percentage, specified in subsection (b), of the gross income from the property excluding from such gross income an amount equal to any rents or royalties paid or incurred by the taxpayer in respect of the property. Such allowance shall not exceed 50 percent of the taxpayer’s taxable income from the property (computed without allowance for depletion). * * * In no case shall the allowance for depletion under section 611 be less than it would be if computed without reference to this section.

But see sec. 613A regarding the percentage depletion allowance for oil and gas wells.

7 SEC. 613A. LIMITATIONS ON PERCENTAGE DEPLETION IN CASE OF OIL AND GAS WELLS.

(a) General Rule. — Except as otherwise provided in this section, the allowance for depletion under section 611 with respect to any oil or gas well shall be computed without regard to section 613 [i.e., without regard to percentage depletion].

See also sec. 613(d), providing as follows:

(d) Denial of Percentage Depletion in Case of Oil and Gas Wells. — Except as provided in Section 613A, in the case of any oil or gas well, the allowance for depletion shall be computed without reference to this section.

8 See. 613A(c) provides in part as follows:

(c) Exemption for Independent Producers and Royalty Owners.—

(1) In general. — Except as provided in subsection (d), the allowance for depletion under section 611 shall be computed in accordance with section 613 with respect to—

(A) so much of the taxpayer’s average daily production of domestic crude oil as does not exceed the taxpayer’s depletable oil quantity; and

(B) so much of the taxpayer’s average daily production of domestic natural gas as does not exceed the taxpayer’s depletable natural gas quantity;

and the applicable percentage (determined in accordance with the table contained in paragraph (5)) shall be deemed to be specified in subsection (b) of section 613 for purposes of subsection (a) of that section.

(2) Average daily production. — For purposes of paragraph (1)—

(A) the taxpayer’s average daily production of domestic crude oil or natural gas for any taxable year, shall be determined by dividing his aggregate production of domestic crude oil or natural gas, as the case may be, during the taxable year by the number of days in such taxable year, and

(B) in the case of a taxpayer holding a partial interest in the production from any property (including an interest held in a partnership) such taxpayer’s production shall be considered to be that amount of such production determined by multiplying the total production of such property by the taxpayer’s percentage participation in the revenues from such property.

In applying this paragraph, there shall not be taken into account any production of crude oil or natural gas resulting from secondary or tertiary processes (as defined in regulations prescribed by the Secretary or his delegate).

(3) Depletable oil quantity.—

(A) In general. — For purposes of paragraph (1), the taxpayer’s depletable oil quantity shall be equal to—

(i) the tentative quantity determined under the table contained in subparagraph (B), reduced (but not below zero) by

(ii) the taxpayer’s average daily secondary or tertiary production for the taxable year. (B) Phase-out table. — For purposes of subparagraph (A)—

In the case of production during the calendar year: The tentative quantity in barrels is:

1975 . .2,000

1976 . .1,800

1977 ... .1,600

1978 . .1,400

1979 . .1,200

1980 and thereafter . .1,000

(4) Daily depletable natural gas quantity. — For purposes of paragraph (1), the depletable natural gas quantity of any taxpayer for any taxable year shall be equal to 6,000 cubic feet multiplied by the number of barrels of the taxpayer’s depletable oil quantity to which the taxpayer elects to have this paragraph apply. The taxpayer’s depletable oil quantity for any calendar year shall be reduced by the number of barrels with respect to which an election under this paragraph applies. Such election shall be made at such time and in such manner as the Secretary or his delegate shall by regulations prescribe.

(5) Applicable percentage. — For purposes of paragraph (1)—

In the case of production The applicable

during the calendar year: percentage is:

1975 .22

1976 .22

1977 . 22

1978 . 22

1979 . 22

1980 . 22

1981 . 22

1982 . 22

1983 . 22

1984 and thereafter

9 In the ease of a taxpayer holding a partial interest m the production of oil and gas from any property, his production for purposes of sec. 613A(c) is to be “determined by multiplying the total production of such property by the taxpayer’s percentage participation in the revenues from such property.” Sec. 613A(c)(2XB).

10 Separate provisions are made for the allowance of percentage depletion on secondary or tertiary production of domestic crude oil and natural gas. See sec. 613A(c)(6).

11 Under sec. 613A(c)(2), a taxpayer’s average daily production is determined with reference to his aggregate production during the “taxable year.” However, the phase-out table in sec. 613A(c)(3) prescribing the tentative number of barrels in the taxpayer’s depletable oil quantity, as well as the table in sec. 613A(c)(5) specifying the percentage to be used in computing percentage depletion, is keyed to the “calendar year.” Thus, if a taxpayer is on a fiscal year, “each portion of such taxable year which occurs during a single calendar year shall be treated as if it were a short taxable year.” Sec. 613A(c)(10).

12 Under sec. 613A(b), which is not pertinent here, certain domestic gas wells are exempt from the repeal of percentage depletion in the case of oil and gas. Natural gas that is exempt under sec. 613A(b) is not to be taken into account in determining a taxpayer’s depletable natural gas quantity under sec. 613A(c). Sec. 613A(c)(ll).

13 For purposes of this election, 6,000 cubic feet of natural gas is equivalent to 1 barrel of oil. Sec. 613A(c)(4).

14 See sec. 1.613A-3(a)(4), examples (4) and (5), Proposed Regs., 42 Fed. Reg. 24281 (May 13, 1977). The proposed regulations provide that percentage depletion is allowable under sec. 613A(c) only with respect to gross income attributable to oil and gas produced in a prior or current taxable year. See sec. 1.613A-7(f), Proposed Regs., 42 Fed. Reg. 24287 (May 13,1977).

15 Petitioners rely heavily on the following portion of the Conference Committee report on the Tax Reduction Act of 1975, Conf. Rept. 94-120 (1975), 1975-1 C.B. 624, 629-630:

"Senate amendment. — Under the Senate amendment, the deduction for percentage depletion is generally eliminated with respect to oil and gas produced on or after January 1,1975, with certain exceptions. These include the exceptions provided under the House bill. In addition, the Senate amendment retains percentage depletion at 22 percent on a permanent basis for the small independent producer to the extent that his average daily production of oil does not exceed 2,000 barrels a day, or his average daily production of natural gas does not exceed 12,000,000 cubic feet. Where the independent producer has both oil and natural gas production, the exemption must be allocated between the two types of production. [Emphasis added.]”

16 See note 11 supra.

17 In this connection, see and compare L. Bravenec, “Continued Availability of Percentage Depletion on Oil and Gas,” 23 Oil & Gas Tax Q. 204, 215-216 (1974-75), with T. Englebrecht & R. Hutchins, "Percentage Depletion Deductions for Oil and Gas Operations: A Review and Analysis," 56 Taxes 48,54 (1978).

18 Sec. 613A(c)(7) provides as follows:

(7) Special rules.—

(A) Production of crude oil in excess of depletable oil quantity. — If the taxpayer’s average daily production of domestic crude oil exceeds his depletable oil quantity, the allowance under paragraph (IXA) with respect to oil produced during the taxable year from each property in the United States shall be that amount which bears the same ratio to the amount of depletion which would have been allowable under section 613(a) for all of the taxpayer’s oil produced from such property during the taxable year (computed as if section 613 applied to all of such production at the rate specified in paragraph (5) or (6), as the case may be) as his depletable oil quantity bears to the aggregate number of barrels representing the average daily production of domestic crude oil of the taxpayer for such year.

(B) Production of natural gas in excess of depletable natural gas quantity. — If the taxpayer’s average daily production of domestic natural gas exceeds his depletable natural gas quantity, the allowance under paragraph (1)(B) with respect to natural gas produced during the taxable year from each property in the United States shall be that amount which bears the same ratio to the amount of depletion which would have been allowable under section 613(a) for all of the taxpayer’s natural gas produced from such property during the taxable year (computed as if section 613 applied to all of such production at the rate specified in paragraph (5) or (6), as the case may be) as the amount of his depletable natural gas quantity in cubic feet bears to the aggregate number of cubic feet representing the average daily production of domestic natural gas of the taxpayer for such year.

19 The House version of the bill contained no exemption for independent producers and royalty owners.

20 Aside from the Conference report cited above, which itself does not adequately explain the complex provisions of sec. 613A(c), the legislative history is quite sketchy. Sec. 613A was introduced as a Senate floor amendment, and as a result the provision was not considered in either the House report (H. Rept. 94-19 (1975), 1975-1 C.B. 569) or the Senate report (S. Rept. 94-36, (1975), 1975-1 C.B. 590) on the bill leading to the Tax Reduction Act of 1975. Similarly, the substance of the debates with respect to the exemption for independent producers and royalty owners is of little assistance in interpreting the provisions of sec. 613A(c).

21 See note 6 supra.

22 Sec. 1.613-5, Income Tax Regs.

23 See the discussion entitled “Taxable Income from the Property for Depletion Purposes” in Miller’s Oil & Gas Federal Income Taxation, eh. 10, p. 145 (J. Houghton ed. 1980).

24 Even so, if there was no production of oil or gas prior to the cancellation of the lease (i.e., no actual depletion), the taxpayer was required to restore the previously deducted depletion to income. Douglas v. Commissioner, 322 U.S. 275, 285 (1944); Sneed v. Commissioner, 119 F.2d 767, 771 (5th Cir. 1941), affg. 40 B.T.A. 1136 (1939), cert. denied 314 U.S. 686 (1942).

25 See note 24 supra; sec. 1.612-3(aX2) and (b)(2), Income Tax Regs.

26 See M. Backus, “A Stitch in Time Necessary to Save Lease Bonus Depletion,” 55 Taxes 313 (1977); L. Bravenec, “Continued Availability of Percentage Depletion on Oil and Gas,” 23 Oil & Gas Tax Q. 204, 211 (1974-75) (while contending that “production” as used in sec. 613A(c) should be interpreted as meaning “sales,” the author notes that it “is difficult to sustain * * * [such a] construction by reference to the statutory language”).

27 Pub. L. 9&-618, 92 Stat. 3204 (Nov. 9,1978). The amendment applies to natural gas produced from geopressured brine and “which is produced from any well the drilling of which began after September 30, 1978, and before January 1, 1984.”

28 See Glass v. Commissioner, 76 T.C. 949 (1981), filed this day.