^rv ^; J ^-^^^ 'ip^- . c.'^^ : -^^^^ •i-^ ' ^-.c.«^' U '-^AO^ o G^ '^ *;^^,^ ^ ^ ^ "oV .1°^ A ;?'^:^ rH-^ f-^"^^^ v-J^^ .. * ^ /■^ .^.TTJ^o^ ^ -.-To- / ^o^^^-^*/ 'V*^'/ '^^^^•^o' V^-'*>' \. f> »i^% '^ 4 o C--^"^^\^'^' V^-y .. v"^*\/' v^'^'%°' "v^'^^'*.^^' : %^ ;MM^ \/ fi\ \^ -^ \/ A: %/ ^il^: ^^' -a 0" = . -^O \^ •p .^^,* .•..•■i,^..v *.. A^ .■^-, *,^^^* ,^^, -^^^/ .^-, -^ ,. /.I,,?.;, *.^^^/ .; '*'- .^ ^ %/ ;^-- %./ .;^$^\/ :>^^- ' Bureau of Mines Information Circular/1985 A Summary of Current and Historical Federal Income Tax Treatment of Mineral Exploration and Development Expenditures By Phillip N. Yasnowsky UNITED STATES DEPARTMENT OF THE INTERIOR w c 3) m > c ^/NES 75TH AV'''^ V Information Circular 9011 A Summary of Current and Historical Federal Income Tax Treatment of Mineral Exploration and Development Expenditures By Phillip N. Yasnowsky UNITED STATES DEPARTMENT OF THE INTERIOR Donald Paul Model, Secretary BUREAU OF MINES Robert C. Morton, Director .Hi- Library of Congress Cataloging in Publication Data: Yasnowsky, Phillip N A summary of current and historical federal income tax treatment of mineral exploration and development expenditures. (Bureau of Mines information circular ; 9011) Bibliography: p. 11-12. Supt. of Docs, no.: I 28.27:9011. 1. Mines and mineral resources— Taxation — Law and legislation- United States. I. Title. II. Series: Information circular (United States. Bureau of Mines) ; 9011. -¥■109^0^4- [KF6495.M5] 622s [343.7305'21 84-600327 CONTENTS Page Abs tract Introduction Exploration and development — definition of terms Current tax treatment of exploration and development expenditures Exploration expenditures Development expenditures Major changes in the Federal tax treatment of exploration and development expenditures Prior to 1951 1951 1954 1960 1966 1969 1976 1982 Public Law 183-82nd Congress (Revenue Act of 1951) Public Law 591, 83rd Congress (Internal Revenue Code Revision) Public Law 86-594 Public Law 89-570 Public Law 91-172 (Tax Reform Act of 1969) Public Law 94-455 (Tax Reform Act of 1976) Public Law 97-248 (Tax Equity and Fiscal Responsibility Act of 1982) Analysis of changes Summary and conclusions References Appendix. — Glossary 1 2 3 4 4 5 6 6 6 7 7 7 8 8 8 9 10 11 13 A SUMMARY OF CURRENT AND HISTORICAL FEDERAL INCOME TAX TREATMENT OF MINERAL EXPLORATION AND DEVELOPMENT EXPENDITURES By Phillip N. Yasnowsky ' ABSTRACT In this Bureau of Mines report, the Federal income tax treatment of mineral exploration and development expenditures is summarized, and changes in the tax treatment of these expenditures since 1951 are de- tailed and analyzed. Although no attempt is made to establish causal relationships, major tax changes favorable to exploration and develop- ment activities did occur in 1951 and 1966 when the Nation was engaged in military actions and the economy was expanding. More recent changes have been unfavorable to exploration and development and were parts of major tax reform efforts. ^Economisr, Branch of Technical Analysis, Bureau of Mines, Washington, DC. INTRODUCTION This Bureau of Mines report discusses the Federal tax law provisions relating to mineral exploration and development expenditures. These provisions, con- tained mainly in sections 616 and 617 of the Internal Revenue Code of 1954 (Title 26 of the U.S. Code), apply specifically to minerals (other than oil and gas) , and thus are of interest to the Bureau of Mines. Bureau of Mines involvement in this subject stems from the legislative man- date in the 1913 amendments to the Organ- ic Act of 1910 (the Act creating the Bureau) to conduct economic investiga- tions of the mineral industries. Con- gressional concern with the economic and financial conditions in the mineral in- dustries was expressed more recently in the Mining and Minerals Policy Act of 1970 and in the National Materials and Minerals Policy, Research, and Develop- ment Act of 1980. The General Accounting Office recommended in 1976 that the De- partment of the Interior "identify and evaluate laws and agency programs that affect maintaining and developing a sound and stable domestic mining and minerals industry" ( 17 , p. iii).^ Taxes, a source of revenue to govern- ments, are a cost to private firms. Thus, taxes directly affect private sec- tor profits, and unique tax provisions are designed to encourage (or discourage) activities such as agriculture, construc- tion, or mining. Even the international competitiveness of the domestic mineral industries may be affected by taxes be- cause many minerals are traded in world markets. Recent major tax law changes and pro- posals for change emphasize the need for timely tax information. Changes in the ^Underlined numbers in parentheses re- fer to items in the list of references preceding the appendix. tax law during the past few years include the Economic Recovery Tax Act of 1981, the Tax Equity and Fiscal Responsibility Act of 1982, and the Deficit Reduction Act of 1984. Major tax proposals in re- cent years include the consumption tax, the value-added tax, and the flat-rate tax. The current tax structure is ex- tremely complicated, and knowledge of its unique provisions is necessary if the effects of proposed changes are to be assessed. In this report, analysis of the changes in the tax treatment of ex- ploration and development costs since 1951 shows how the current tax treatment has evolved. Of course, it would be un- wise to place too much emphasis on the analysis of specific tax provisions; ul- timately, it is the total tax system that must be evaluated on the basis of select- ed criteria. However, the analysis of specific provisions is more manageable, and these provisions reflect the special problems in taxation encountered in areas such as natural resources. This report is directed toward the gen-" eral reader and, consequently, does not cover all details of the tax law pertain- ing to exploration and development expen- ditures. The reader interested in more detail should consult either the tax law and regulations or references such as those in the reference section of this report (J^-2, 5), A brief section con- taining definitions of exploration and development precedes the tax discussion; definitions of other terms are in the appendix. Some repetition of material in the fol- lowing discussions, especially in the part on the current tax treatment of exploration and development costs, is necessary to keep each section self- contained. In addition, the parallel discussions are useful in highlighting the similarities and differences in the treatment of each of these costs. EXPLORATION AND DEVELOPMENT — DEFINITION OF TERMS DeYoung and Singer (_3, pp. 940, 944- 945) identify six stages in the mineral supply process: exploration, develop- ment, mining (production), crushing and concentrating, smelting, and refining. Only the first three of these stages per- tain to this paper, and the discussion in this section is limited to them. These stages are sequential in that some results in each one are necessary for an advance to the following stage (3^, p. 945). For example, a mineral deposit must be discovered (result of explora- tion) before it can be prepared for com- mercial production (development) . On the other hand, the stages may overlap if further exploratory efforts are made at the same time that development work is being pursued. For tax purposes, the distinction between the exploration and development stages is important because the tax treatment of the expenditures as- signed to these respective categories differs significantly. A definition of exploration is implied in the Internal Revenue Code, which defines exploration expenditures as those expenditures for "...the purpose of ascertaining the existence, location, extent, or quality of any deposit of ore or other mineral, and paid or in- curred before the beginning of the de- velopment stage of the mine, . . ."(10, sec. 617). Thus, for tax purposes, the definition of exploration is based on the stage of the mineral supply process. Any exploration-type expenditures, such as for core drilling, made after the start of the development stage are con- sidered to be development expenditures (U p. 2002). Development is essentially the prepara- tion of a mineral deposit for commercial production after its existence has been determined by exploration. More detail of this activity can be obtained from the following definition of development expenditures. A rather comprehensive definition of exploration is given in Part 229, Chapter II, Title 30 (Mineral Resources) of the Code of Federal Regulations, which deals with obtaining federal financial assist- ance for mineral exploration. 'Exploration' means the search, including related development work, for new or unexplored min- eral deposits within a specified area or parcel of ground where geologic conditions favor their occurrence. Exploration using recognized and sound procedures , including standard geophysical and geochemical methods , may be conducted from the surface or un- derground to obtain information. The work shall not go beyond a reasonable delineation and samp- ling of a mineral deposit, and shall not be conducted primarily for mining or preparation for mining. Mine development costs consist of those expenditures necessary to gain access to orebodies in the preproduction stage and to extend production in an existing ore- body, including costs for remov- ing overburden, sinking shafts, extending tunnels, and other ex- penditures that will be of no value after the exhaustion of the orebody (5^, p. 35) . Development expenditures are not de- fined in the Internal Revenue Code, but instead are referred to as "all ex- penditures paid or incurred during the taxable year for the development of a mine or other natural deposit (other than an oil or gas well) if paid or incurred after the existence of ores or minerals in commercially marketa- ble quantities has been disclosed" ( 10, sec. 616). Unlike the sharp tax dis- tinction made between expenditures in the exploration and the development stages, development expenditures may be incurred in both the development and production stages. The tax treatment of development expenditures and operat- ing (production) expenditures does dif- fer, but not as significantly as between exploration and development expenditures. The following diagram summarizes the re- lationship between the three stages and the assignment of expenditures for tax purposes. Expenditures Exploration Development Production Stage of the Mineral Supply Process -^ Exploration. -> Development. ^ Production. In short, exploration expenditures can be incurred only in the exploration stage, and development expenditures can be in- curred in both the development and pro- duction stages. CURRENT TAX TREATMENT OF EXPLORATION AND DEVELOPMENT EXPENDITURES3 EXPLORATION EXPENDITURES In general, a corporate taxpayer can deduct as incurred 85 pet (80 pet after 1984) of the domestic exploration expend- itures. The other 15 pet (20 pet after 1984) is to be capitalized and recovered over a period and at a rate equivalent to that for 5-year property under the Accel- erated Cost Recovery System. The alter- native is to capitalize the exploration expenditures and recover them through the depletion allowance. The general provision allowing the ex- pensing of exploration costs is contained in section 617 of the Internal Revenue Code, "Deduction and Recapture of Certain Mining Exploration Expenditures." Sec- tion 291 of the code, "Special Rules Re- lating to Certain Corporate Preference Items," contains the provision that lim- its the expensed amount to 85 pet (80 pet after 1984). It should be noted that section 617 does not refer to the limita- tion imposed by section 291, which was added by the Tax Equity and Fiscal Re- sponsibility Act of 1982. Oil and gas exploration expenditures are not covered by section 617, nor are exploration expenditures deductible for any mineral not eligible for the percent- age depletion allowance. Thus, materials such as soil, water, or minerals from sea water are not included. Costs that are deductible as incurred under other pro- visions of the code, such as State and local taxes, are not to be deducted as exploration expenditures. Further, the costs of items subject to a depreciation allowance cannot be immediately deduct- ed. Deductions to recover these costs must be made over time, subject to the tax rules for depreciation. The depreci- ation deduction that is available, how- ever, is considered to be an exploration expenditure. The expensing of expenditures for ex- ploration outside of the United States is limited to a maximum of $400,000. This is a total per taxpayer limit, and the maximum is reduced by any exploration expenditures, domestic or foreign, pre- viously expensed. Therefore, except to a very limited extent, foreign explo- ration expenditures are to be capital- ized and recovered through the depletion allowance. A provision known as recapture lessens some of the tax benefit of expensing ex- ploration costs. Exploration expendi- tures associated with a particular ef- fort, which are expensed, are subject to recapture when the producing stage is reached. Recapture takes place either by adding the previously expensed costs to gross income or by forgoing the depletion deduction until the amount forgone is equal to the total of the expenditures that were deducted. If the former choice is taken, the amount recaptured is added ^The percent of exploration and devel- opment expenditures that cannot be ex- pensed was increased to 20 pet from 15 pet, effective after 1984, by the Deficit Reduction Act of 1984. to the basis of the property and recover- able through the depletion allowance. Section 291 (b) of the Internal Revenue Code, effective for tax years starting in 1983, provides that the immediate deduc- tion for exploration expenditures under section 617 be reduced by 15 pet (20 pet after 1984). In other words, 85 pet (80 pet after 1984) of the exploration ex- penditures still may be deducted as in- curred. The 15 pet (20 pet after 1984) is to be capitalized and may be written off according to the following schedule, which is equivalent to that for 5-year property under the Accelerated Cost Re- covery System. Year Percent deducted 1st 15 2d 22 3d 21 4th 21 5th 21 Total 100 The capitalized 15 pet (20 pet after 1984) also qualifies for the investment tax credit. Finally, there are a couple of explora- tion cost tax provisions that apply only to individuals as opposed to corpora- tions. Section 57 of the Code, "Items of Tax Preference," lists exploration costs as an item of tax preference for noncor- porate taxpayers for purposes of the min- imum tax. The deduction under section 617 is a tax preference item in a given year to the extent that it is greater than the amount that would have been de- ducted if the costs were deducted over a 10-year period. Section 58 gives the individual taxpayer the option of deduct- ing exploration costs over a 10-year per- iod; the deduction for exploration costs then would not be subject to the minimum tax. DEVELOPMENT EXPENDITURES A corporate taxpayer can deduct as in- curred 85 pet (80 pet after 1984) of de- velopment expenditures. The remaining 15 pet (20 pet after 1984) is to be capital- ized and recovered over a period and at a rate equivalent to that for 5-year prop- erty under the Accelerated Cost Recovery System. An option is to defer the devel- opment costs and deduct them ratably over time with the sales of the affected min- eral. If this option is selected, only the expenditures greater than net re- ceipts can be deferred while the mine is in the development stage. The general provision allowing the im- mediate deduction of development costs is contained in section 616 of the Internal Revenue Code, "Development Expenditures." Section 291 of the code, "Special Rules Relating to Certain Corporate Preference Items," contains the provision that lim- its the deduction to 85 pet (80 pet after 1984) . Section 616 does not refer to the limitation imposed by section 291, which was added by the Tax Equity and Fiscal Responsibility Act of 1982. Oil and gas development expenditures are not covered by section 616. Costs that are deductible as incurred under other provisions of the code, such as State and local taxes, are not deductible as development expenditures. The costs of items subject to a depreciation allow- ance cannot be expensed, but these costs must be recovered over time, subject to the tax rules for depreciation. The de- preciation expense, however, is consid- ered to be a development expenditure. Section 291 (b) of the Internal Revenue Code, effective for tax years beginning in 1983, provides that the immediate deduction for development expenditures under section 616 be reduced by 15 pet (20 pet after 1984). This 15 pet (20 pet after 1984) is to be capitalized and written off according to a schedule equivalent to that for 5-year property under the Accelerated Cost Recovery Sys- tem (the same schedule shown earlier un- der Exploration Expenditures). The capi- talized 15 pet (20 pet after 1984) also qualifies for an investment tax credit. Finally, there are a couple of develop- ment cost tax provisions that apply only to individuals, as opposed to corpora- tions. Section 57 of the code, "Items of Tax Preference," lists development costs as an item of tax preference for noncor- porate taxpayers for purposes of the min- imum tax. The deduction under section 616 is a tax preference item to the ex- tent that it is greater than the amount that would have been deducted if the costs were deducted ratably over a 10- year period. Section 58 gives the indi- vidual taxpayer the option of deducting development costs over a 10-year period; the deduction of development costs would then not be subject to the minimum tax. MAJOR CHANGES IN THE FEDERAL TAX TREATMENT OF EXPLORATION AND DEVELOPMENT EXPENDITURES This section details the major changes in the tax treatment of exploration and development costs since 1951. The rea- sons for the changes , as stated in the reports of the House Ways and Means and the Senate Finance Committees, are given. In addition, an analysis of the changes based on the general economic conditions and the status of the mineral industries at the time of the more significant changes is provided. The general status of the mineral industries is shown by aggregate measures, but the conditions for individual companies and minerals will often vary considerably, PRIOR TO 1951 Prior to the Revenue Act of 1951, ex- ploration expenditures that resulted in production had to be capitalized and re- covered through the depletion allowance. Exploration expenditures for unsuccessful efforts could be deducted as losses. During the development stage, development expenditures in excess of net receipts were to be capitalized and recovered through the depletion allowance. During the production stage, development expend- itures were generally deductible as incurred. However, extraordinary expend- itures were treated as prepaid expenses and had to be deferred and deducted ratably over time with sales ( 16 , pp. 25- 26, 43). 1951: PUBLIC LAW 18 3-8 2nd CONGRESS (REVENUE ACT OF 1951) The Revenue Act of 1951 followed two other revenue-raising acts, the Revenue Act of 1950 and the Excess Profits Act of 1950. Justification for these measures was provided in the House Ways and Means Committee report on the 1951 Act, which stated that "The military action in Korea, coupled with the general threat to world peace, has made it necessary to provide extraordinary increases in reve- nue to meet essential national defense expenditures" (23, p. 1). However, the tax changes related to exploration and development expenditures were revenue- reducing, rather than revenue-increasing, provisions. By adding subsection "ff" to section 23 of the Internal Revenue Code of 1939, the 1951 Revenue Act provided that a tax- payer could deduct as incurred explora- tion expenditures up to $75,000 per year for any 4 years, or a total of $300,000. This provision specifically excluded items that were subject to depreciation under the tax law. However, the allowed depreciation deduction for such items was to be considered part of the exploration expenditures. Expenditures in excess of the dollar limitations were to be capi- talized and recovered through the deple- tion allowance. As an alternative to ex- pensing the exploration expenditures, the taxpayer could defer the costs and deduct them ratably over time with sales. The dollar limitations were the same regard- less of the option, or combination of options, chosen. The same act, by adding subsection "cc" to section 23 of the Internal Revenue Code of 1939, provided for the immediate deduction of development expenditures re- gardless of whether such expenditures were made in the development or produc- tion stage. The deduction was not al- lowed for items subject to depreciation under the tax law, but the depreciation allowances were to be considered develop- ment expenditures. As an alternative to expensing, the taxpayer could defer the development expenditures and deduct them ratably over time with sales of the affected minerals. Development expendi- tures made during the development stage had to be in excess of net receipts be- fore they could be deferred; in other words, an amount up to net receipts had to be deducted as incurred. The Revenue Act of 1951 was primarily a revenue-increasing measure. The Report of the Senate Finance Committee explained why the provision for the expensing of some exploration costs, which would re- duce tax revenue, was included in the act. First, the report stated that the Nation's mineral supply position was not adequate for meeting the demands of the economy, "especially in an emergency period..." (2_9, p. 63). Second, the re- port pointed out that exploration expend- itures were recovered through the deple- tion allowance, but the form of depletion commonly used (percentage depletion) was based on gross income. Thus, there was no special incentive for making explora- tion outlays. The Senate report provided essentially the same two arguments for the expensing of development expendi- tures. In addition, the disparity in the tax treatment of development expenditures in the development and production stages was considered undesirable because they were "essentially similar" (29, pp. 43- 45, 63). ~ 1954: PUBLIC LAW 591, 83RD CONGRESS (INTERNAL REVENUE CODE REVISION) In 1954, the Congress undertook a major revision of the Federal tax laws that re- sulted in the Internal Revenue Code of 1939 being replaced by the Internal Reve- nue Code of 1954. The 1954 code, as amended, remains in effect. The major purposes of the revision were to arrange the provisions of the code in a more log- ical manner and to make them more under- standable. One result of this effort was the creation of Subchapter I (sections 611-638), which deals exclusively with natural resources, especially minerals. An additional purpose of the code revi- sion was "to reduce tax barriers to fu- ture expansion of production and employ- ment" (21, p. 1). The restructuring of the code resulted in new section numbers 615 (repealed in 1976) and 616 being assigned to the tax treatment of exploration costs and devel- opment costs, respectively. More im- portant, however, a Senate amendment, which the House agreed to in conference, provided for increases in the limits on the amount of exploration expenditures that could be expensed or deferred and deducted ratably to $100,000 annually and $400,000 overall (J_9, p. 53). The Senate Finance Committee Report contained no comment or reason other than acknowledg- ing that this action had been taken ( 27 , p. 80). The 4-year time limitation still held. 1960: PUBLIC LAW 86-594 The only purpose of Public Law 86- 594, passed in 1960, was to remove the 4-year limitation during which explora- tion expenditures could be expensed or deferred. The limits of $100,000 annual- ly and $400,000 in total per taxpayer re- mained in effect. Senate Finance Committee and House Ways and Means Committee reports noted that the 4-year limit discriminated against small mineral producers who might be mak- ing less than $100,000 of exploration outlays in any one year. These producers would never get to expense the total al- lowable limit of $400,000, but larger operators with annual exploration expend- itures of $100,000 or more would always be able to make full use of the immediate deduction. By removing the 4-year limi- tation, the small producers eventually might expense the total limit of $400,000 per taxpayer ( 20 , 28) . 1966: PUBLIC LAW 89-570 Public Law 89-570, which dealt only with exploration outlays and which added section 617 to the Internal Revenue Code of 1954, provided for the expensing with- out limit of expenditures made for ex- ploration in the United States (including the Outer Continental Shelf) ; in other words, the $100,000 annual and $400,000 total limitations were removed. However, once the producing stage of a mine was reached, the amount so deducted had to be recaptured. Recapturing was to be either by adding the amount of the previous ex- ploration deductions to income or by for- going the depletion deduction until the depletion deduction forgone was equal to the exploration deductions. The taxpayer still retained the option of deducting domestic exploration expenditures under section 615 of the code. Section 615, while having the disadvantage of the dol- lar limitation, had the advantage of not providing for recapture. Section 615 still applied to foreign exploration expenditures. The House Ways and Means Committee and Senate Finance Committee reports (_1_8, pp. 1-3; ^, pp. 1-3) contained several rea- sons for liberalizing the tax treatment of exploration expenditures. First, the tax incentive for exploration was quite limited under the current law because many mineral producers had reached the $400,000 limit, which could be deducted immediately or deferred and deducted ratably with sales. Second, the writeoff for unsuccessful expenditures, available upon the abandonment or disposal of the property, was not available much of the time. Mineral properties were frequently kept in anticipation of successful ex- ploration activity in the future or of the availability of techniques to utilize lower grade ores more efficiently. Both committees maintained that "these re- strictive effects of present law on ex- ploration expenditures are undesirable." 1969: PUBLIC LAW 91-172 (TAX REFORM ACT OF 1969) The House Ways and Means Committee and the Senate Finance Committee reports on the Tax Reform Act of 1969 described it as a "substantive and comprehensive re- form of the income tax laws" (24, p. 1; 31 , p. 1). It was stated that numerous tax preferences had been enacted over the years and that the situation in this regard had gotten out-of-hand. A more fair distribution of the tax burden was deemed essential. The Ways and Means Committee bill contained 27 and the Finance Committee bill 34 "groups of tax reform provisions," and in each bill one group was natural resources. One of the numerous provisions enacted provided that the recapture rules apply to all mineral exploration expenditures that are expensed: There would no longer be the limited deduction as incurred without recapture under section 615. The title of section 615 became "Pre-1970 ex- ploration expenditures," and the limita- tion of $400,000 per taxpayer for foreign exploration expenditures was included in section 617. The committee reports stated specific reasons for making all expensed explora- tion outlays subject to recapture, in addition to the ones for general tax re- form. First, most affected taxpayers used the unlimited deduction with recap- ture. Second, the Committees, while ac- cepting the incentive aspect of expensing exploration expenditures, viewed the de- duction without recapture combined with the percentage depletion allowance as un- necessary "to provide the desired incen- tive" to undertake mineral activities (24, p. 143; 21)- 1976: PUBLIC LAW 94-455 (TAX REFORM ACT OF 1976) The basic objectives of the Tax Reform Act of 1976 related to equity, simpli- fication, and economic growth. As a result of the simplification process, section 615, "Pre-1970 exploration ex- penditures," was repealed. This sectioti was 1 of nearly 150 sections of the In- ternal Revenue Code repealed under "Title XIX — Repeal and Revision of Obsolete, Rarely Used, etc. , Provisions of Internal Revenue Code of 1954" of the 1976 Act be- cause they were no longer significant for tax purposes ( 25 , pp. 3, 385; 32^, pp. 2, 506). 1982: PUBLIC LAW 97-248 (TAX EQUITY AND FISCAL RESPONSIBILITY ACT OF 1982) The Tax Equity and Fiscal Responsibil- ity Act of 1982 contained numerous provi- sions affecting a wide range of tax- payers. The main objectives of the act related to revenue raising, increasing equity among taxpayers, eliminating dis- tortions in economic behavior caused by the tax system, and allocating the cost of government services to users. One of the approaches to achieving, at least partially, several of these broad objec- tives was a 15 pet reduction in selected tax preferences for corporations. One of the selected tax preferences was the ex- pensing of exploration and development costs. The 1982 act provided for a reduction in the allowable immediate deduction for exploration and development costs to 85 pet of such costs. The remaining 15 pet is capitalized and may be written off over 5 years. The capitalized portion of exploration and development expenditures qualifies for the investment tax credit. These changes, along with the reductions in the other selected tax preferences, are contained in section 291 of the Internal Revenue Code and are not men- tioned in sections 616 and 617. Three reasons for the reduction in tax preferences were given in the Senate Finance Committee report. First, the large budget deficits warrant cutbacks in tax preferences as well as in direct spending. Second, the Accelerated Cost Recovery System, enacted in 1981, pro- vides a considerable incentive for in- vestment, and this makes other incentives less necessary. Third, the equity of the tax system is enhanced by such a measure (30, p. 118). ANALYSIS OF CHANGES The following tabulation summarizes the changes in the tax treatment of explora- tion and development expenditures. Prior to 1951: Exploration — capitalized. Development: Development stage — capitalize amount in excess of net receipts. Production stage — expense or, if extraordinary, defer and deduct ratably over time with sales. 1951: Exploration — expense $75,000 annually for 4 years. Development — expense. 1954: Exploration — expense $100,000 annually for 4 years. I960: Exploration — no longer a 4-year limit. 1966: Exploration — expense without limit but with recapture. 1969: Exploration — no longer a limited ($400,000) deduction without recapture. 1976: Exploration — repealed obsolete provision of limited deduction with- out recapture. 1982: Exploration and Development — reduced the amount that can be ex- pensed by 15 pet. Since 1951, the only major change in the Federal income tax treatment of mineral development expenditures has been that in 1982. Changes in the tax provisions affecting exploration expenditures were more frequent and occurred in 1951, 1954, 1960, 1966, 1969, 1976, and 1982. Of course, these changes varied considerably in their significance. Although there are too few observations to establish a definite trend, it may be noted that the tax treatment of these costs was liberal- ized in the four changes between 1951 and 1966, and made more restrictive in the two substantive changes between 1969 and 1982. The most significant changes in the tax treatment of mineral exploration and de- velopment expenditures occurred in 1951, 1966, 1969, and 1982. (Only exploration expenditures were affected in 1966 and 1969.) The 1969 change, while not im- portant in an absolute sense, indicated a reversal in direction from more liberal to more restrictive tax treatment. The 1966 change is the only one of the four most significant changes that was the subject of a law itself; the other three changes were incorporated as part of larger tax measures. In 1950 and 1951, the U.S. mineral industries were operating at high levels of capacity due to "the high level of employment and demand sustained by the Korean War and by the general progress of the economy" {]_, p. 1). Profitability, measured by profits after income taxes as a percent of stockholders' equity, in the mineral-related industries (iron and steel, nonferrous metals, stone, clay, and glass) was generally above the aver- age for all manufacturing industries dur- ing 1950 and 1951 (13). The national in- come originating in metal and nonraetal (excluding fuels) mining, a quantitative measure of the economic importance of mining in the economy, was about 0.49 pet of total national income in both 1950 and 1951 (^4). In addition, there was concern about mineral shortages. The Paley Commission was established in early 1951 and issued its report in June of 1952 (J_2 ) . One of the Commission's recommendations was that exploration costs be currently deductible without limit, a change not enacted until 1966. It is noteworthy, also, that the Revenue Act of 1951, primarily a revenue- raising measure, contained revenue- reducing provisions with regard to ex- ploration and development costs. nonferrous metals was 8-pct below the all-manufacturing average in 1965, but in 1966 had increased to 10 pet above it (13) . The national income originating in nonfuel mining, as a percent of total national income, was appproximately 0.35 pet in both 1965 and 1966, down consid- erably from the figure of 0.49 pet in both 1950 and 1951 ( j^) . The first negative (to mining) change in the tax treatment of exploration costs occurred in 1969 as part of tlie Tax Re- form Act of 1969. This change was sig- nificant in that it signaled a new direc- tion for this mineral tax provision. The profit rates for the mineral-related in- dustries in 1968 and 1969 were mixed when compared to the all-manufacturing aver- ages. The profit rates for the iron and steel and the stone, clay, and glass in- dustries remained below the average, as they had for nearly the whole decade. The only exception was in 1960 when the profit rate for stone, clay, and glass was slightly above the all-manufacturing average (13). The national income origi- nating in nonfuel mining, as a percent of total national income, was about 0.29 pet in both 1968 and 1969, down significantly from both the 1950-51 and 1965-66 levels (14). In 1965 and 1966, as in 1950 and 1951, the mineral industries were performing quite well in the generally favorable economic conditions. The 1966 Bureau of Mines Minerals Yearbook recorded that "a booming economy, with rising consumer demand at home and the pressures on sup- ply from the Viet Nam war, strained pro- duction capacity in many of the mineral and mineral fuel industries in 1966" (9^, p. 24). Profit rates in the mineral- related industries, relative to the all- manufacturing averages , were mixed in 1965 and 1966. Iron and steel profit rates were below the average, as they had been since 1958. The profit rate for The latest negative change occurred in 1982, a dismal year for the mineral in- dustries. Profitability in all three of the mineral-related industries was below the all manufacturing average during both 1981 and 1982. More significantly, the iron and steel and the nonferrous metals industries suffered losses in 1982 (13) . The value of U.S. nonfuel mineral produc- tion in constant (1972) dollars had reached a peak in 1979 and then dropped in 1980, 1981, and 1982. The national income originating in mining, as a per- cent of total national income, was 0.29 pet in 1981 and 0.24 pet in 1982 (15). SUMMARY AND CONCLUSIONS Any conclusions drawn from the above analysis must be interpreted with a con- siderable degree of caution for several reasons. First, the provisions dealing with exploration and development expendi- tures are only a small part of the total ww^aMi o mwu i uinw HNyuLvoun 11 tax law. Because of other changes in the tax law, it cannot be definitively stated that the total Federal income tax burden on the mineral industries changed in ac- cordance with the change in the provi- sions related to exploration and develop- ment costs. Second, no attempt is made to establish causal relationships with the information in this report. There are too few observations and too many- factors involved in determining both tax policy and conditions in the mineral in- dustries to warrant speculation on causal relationships. However, some generaliza- tion is possible. The two positive changes in the tax treatment of exploration and development expenditures, in 1951 and 1966, are as- sociated with times when the Nation was engaged in military actions and the econ- omy, including the mineral industries, was expanding. Congressional reports in- dicated an interest in expanding miner- al production. The latest changes, in 1969 and 1982, were restrictive and were part of major acts concerned with tax reform and equity. In 1982, conditions in the mineral industries were severely depressed. This more restrictive tax treatment for exploration and development expenditures is also associated somewhat with the relative decline in national in- come originating in mining. REFERENCES 1. Burke, F. M. , Jr., and R. W. Bow- hay. Income Taxation of Natural Re- sources. Prentice-Hall, 1984, 31 ch. 2. Coopers and Lybrand. Mining Taxa- tion: A Global Survey. 1983, 66 pp. 1950. Ch. in BuMines 1950, V. 1, pp. 1-28. Minerals Yearbook 9. Morrison, W. E. Review of the Mineral Industries. Ch. in BuMines Min- erals Yearbook 1966, v. 1-2, pp. 1-76. 3. DeYoung, J. H. , Jr., and D. A. Singer. Physical Factors That Could Restrict Mineral Supply. Econ. Geol. , 75th Anniversary Volume, 1981, pp. 939- 954. 4. Hoffman, W. H. , Jr., and E. Willis (eds.). West's Federal Taxation: Com- prehensive Volume, 1983 Annual Edition, West Pub. , 1983, 1104 pp. 5. Janson, E. C, S. C. Knup , and D. T. Wright. Financial Reporting and Tax Practices in Nonferrous Mining. Coopers and Lybrand, New York, 10th ed. , 1981, 148 pp. 6. Johnson, E. E. , and P. N. Yasnow- sky. Review of the Mineral Industries. Ch. in BuMines ^-linerals Yearbook 1965, v. 1, pp. 1-33. 7. McGann, P. W. Review of the Min- eral Industries in 1951. Ch. in BuMines Minerals Yearbook 1951, v. 1, pp. 1-32. 10. Prentice-Hall, Inc. Federal Tax Guide, Code Volume. Internal Revenue Code of 1954. 1977 (looseleaf , with up- dated suppl. ) . 11. . Federal Tax Guide, Regula- tions Volumes (2). Income Tax Regula- tions. 1983 (looseleaf with updated suppl. ) . 12. President's Materials Policy Com- mission. Resources for Freedom. V. 1, Foundations for Growth and Security, June 1952, 184 pp. 13. U.S. Bureau of the Census. Quar- terly Financial Report for Manufacturing, Mining, and Trade Corporations. Quarter- ly, 1950-83. 14. U.S. Bureau of Economic Analysis (Dep. Commerce). The National Income and Product Accounts of the United States, 1929-76, Statistical Tables. Sept. 1981, 429 pp. 8. McGann, P. W. , and L. L. Fisch- 15. man. Review of the Mineral Industries in ness. Survey of Current Busl- V. 63, No. 7, July 1983, p. 69. 12 16. U.S. Congress. Summary of the Provisions of the Revenue Act of 1951 (H.R. 4473) As Agreed to by the Con- ferees. Joint Committee on Internal Rev- enue Taxation. Oct. 1951, 75 pp. 17. U.S. General Accounting Office. Need To Develop a National Non-Fuel Min- eral Policy. RED-76-86, July 2, 1976, 39 pp. 18. U.S. House of Representatives. Income Tax Treatment of Exploration Ex- penditures in the Case of Mining. Com- -^mittee on Ways and Means. 89th Congr. , 2d sess.. Rep. 1237, Feb. 1, 1966, 20 pp. 19. 1954. Internal Revenue Code of Conference Report To Accompany H.R. 8300. 83d Congr., 2d sess.. Rep. 2543, July 26, 1954, 86 pp. 20. . Limitation on Deduction of Exploration Expenditures. Committee on Ways and Means. 86th Congr., 1st sess.. Rep. 1054, Aug. 26, 1959, 4 pp. 21. , Report of the Committee on Ways and Means To Accompany H.R. 8300, a Bill To Revise the Internal Revenue Laws of the U.S. 83d Congr,, 2d sess., Rep. 1337, Mar. 9, 1954, 109 pp., plus append. 22. Revenue Act of 1951. Conference Report To Accompany H.R. 4473. 82d Congr., 1st sess.. Rep. 1179, Oct. 15, 1951, 109 pp. 23. Revenue Act of 1951. Re- port of the Committee on Ways and Means. 82d Congr. 1st sess.. Rep. 586, June 18, 1951, 152 pp. 24. . Tax Reform Act of 1969. Committee on Ways and Means. 91st Congr., 1st sess.. Rep. 91-413, pt. 1, Aug. 2, 1969, 226 pp. 25. Tax Reform Act of 1976. Committee on Ways and Means. 94th Congr., 1st sess.. Rep. 94-658, Nov. 12, 1975, 476 pp. 26. U.S. Senate. Income Tax Treatment of Exploration Expenditures in the Case of Mining. Committee on Finance. 89th Congr., 2d sess.. Rep. 1377, July 19, 1966, 21 pp. 27. Internal Revenue Code of 1954, Report of the Committee on Fi- nance. 83d Congr., 2d sess., Rep. 1622, June 18, 1954, 628 pp. 28. Limitation on Deduction of Exploration Expenditures. Committee on Finance. 86th Congr., 2d sess.. Rep. 1137, Feb. 24, 1960, 7 pp. 29. Revenue Act of 1951. Re- port of the Committee on Finance. 82d Congr., 1st sess.. Rep. 781, Sept, 18, 1951, 120 pp. 30. Tax Equity and Fiscal Re- sponsibility Act of 1982. Committee on Finance. 97th Congr,, 2d sess,. Rep, 97- 494, July 12, 1982, 434 pp. 31, Tax Reform Act of 1969, Committee on Finance, 91st Congr, , 1st sess,, Rep, 91-552, Nov, 21, 1969, 352 pp. 32, Tax Reform Act of 1976. Committee on Finance. 94th Congr. , 2d sess.. Rep. 94-938, June 10, 1976, 607 pp. 13 APPENDIX. —GLOSSARY Accelerated Cost Recovery System . — "An arbitrary means where the cost of tangi- ble property is recovered over a pre- scribed period of time. Enacted by the Economic Recovery Tax Act (ERTA) of 1981, the approach disregards salvage value and imposes a period of recovery that depends upon the classification of the asset" (_4, p. 995). Basis . — "The amount assigned to an as- set for income tax purposes. For assets acquired by purchase, basis would be cost." Adjusted basis is the "cost or other basis of property reduced by depre- ciation [or depletion] allowed or allowa- ble and increased by capital improve- ments" (A, pp. 997, 1000). and 22 depending on the mineral, of the gross income from the mineral property. Depreciation . — "The write-off for tax purposes of the cost or other basis of a tangible asset over its estimated useful life" (_4, p. 1007). Expensing . — The taking of a deduction, used in computing taxable income, immedi- ately (during the current tax period). Also referred to as "deducting as in- curred" or to "currently deduct." Investment tax credit. — A credit against the income tax liability equal to a specified percent of qualified invest- ment made by the taxpayer. Capitalize . — To treat an expenditure as an acquisition, or addition to the basis, of property, the cost of which is to be recovered over time through depreciation or depletion. Depletion . — A deduction in computing taxable income for the depletion of tim- ber and minerals. There are two methods of depletion computation authorized by Federal tax law: cost depletion and per- centage depletion. Cost depletion is computed by dividing the cost basis by the estimated reserves and then multiply- ing this figure by the annual sales in physical units. Percentage depletion, available only for minerals, is computed by taking a specified percent, between 5 Minimum tax on items of tax prefer- ence . — A tax, enacted in 1969, to ensure that taxpayers whose taxable income was reduced due to certain deductions or to special treatment of certain types of in- come (tax preferences) would be liable for at least some (a minimum) tax. The minimum tax is levied in addition to the regular income tax. Ratably . — Same as proportionately. Recapture . — "To recover the tax benefit of a deduction or a credit previously taken" (A_, p. 1025). 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