Mitsubishi Cement holding affirmed on appeal

Tax Hot Topics newsletter The Ninth Circuit Court of Appeals affirmed the Tax Court’s decision in Mitsubishi Cement Corp. & Subsidiaries v. Commissioner, No. 19-71401 (Nov. 13, 2020), that mining costs do not include purchased minerals added to the cement-making process for purposes of computing percentage depletion under Section 613.

The taxpayer in the case mines calcium carbonate and adds in purchased minerals to produce cement for sale. In computing its percentage depletion, it used the proportionate profits method and calculated its gross income from mining by including the costs of minerals purchased from third parties.

A taxpayer who conducts both mining and non-mining activities with respect to a given mineral (as in the manufacture of finished products like cement) must allocate gross income from the two activities. The percentage depletion rate is applied only to the gross income from mining. The taxpayer argued that the purchased minerals should be included because they qualified as a treatment process applied to the calcium carbonate that the company mined to make cement.

The courts rejected the taxpayer’s arguments and held that the cost of purchased minerals was a non-mining cost because the taxpayer has no depletable interest in the purchased minerals. Although the statute provides that a treatment process is part of mining costs for percentage depletion, the courts held that the purchased minerals were not part of a treatment process to mine the calcium carbonate, but instead were additives used to make cement. The Tax Court also noted that depletion allowances must be calculated separately for individual mineral properties combined in a mixture and that the regulations specifically provide that mining does not include purchasing minerals from another or the application of processes to purchased minerals.

In addition, the courts rejected the taxpayer’s reliance on a regulation published in 1960 allowing a 15% depletion rate that was superseded by a statutory change in 1969, which required a 14% rate. The Ninth Circuit also upheld the Tax Court’s decision that the taxpayer could not increase its percentage depletion deduction by increasing its gross sales from mining as a result of substituting average prices per ton that unrelated parties paid for the prices that were used in actual sales to its controlled subsidiaries, stating that the taxpayer failed to prove that the unrelated party sales were “representative”of the market. The Tax Court had additionally held that the regulations do not allow the taxpayer to increase gross sales by relying on representative market prices because it sold its products to members of the controlled group at substantial discounts.

Sharon Kay
Washington National Tax Office
T +1 202 861 4140

Caleb Cordonnier
Washington National Tax Office
T +1 202 521 1555

Pinky Shodhan
Senior Associate
Washington National Tax Office
T +1 202 521 1556

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