[Code of Federal Regulations]
[Title 26, Volume 7]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.636-3]

[Page 549]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.636-3  Definitions.

    For purposes of section 636 and the regulations thereunder:
    (a) Production payment. (1) The term production payment means, in 
general, a right to a specified share of the production from mineral in 
place (if, as, and when produced), or the proceeds from such production. 
Such right must be an economic interest in such mineral in place. It may 
burden more than one mineral property, and the burdened mineral property 
need not be an operating mineral interest. Such right must have an 
expected economic life (at the time of its creation) of shorter duration 
than the economic life of one or more of the mineral properties burdened 
thereby. A right to mineral in place which can be required to be 
satisfied by other than the production of mineral from the burdened 
mineral property is not an economic interest in mineral in place. A 
production payment may be limited by a dollar amount, a quantum of 
mineral, or a period of time. A right to mineral in place has an 
economic life of shorter duration than the economic life of a mineral 
property burdened thereby only if such right may not reasonably be 
expected to extend in substantial amounts over the entire productive 
life of such mineral property. The term production payment includes 
payments which are commonly referred to as in-oil payments, gas 
payments, or mineral payments.
    (2) A right which is in substance economically equivalent to a 
production payment shall be treated as a production payment for purposes 
of section 636 and the regulations thereunder, regardless of the 
language used to describe such right, the method of creation of such 
right, or the form in which such right is cast (even though such form is 
that of an operating mineral interest). Whether or not a right is in 
substance economically equivalent to a production payment shall be 
determined from all the facts and circumstances. An example of an 
interest which is to be treated as a production payment under this 
subparagraph is that portion of a royalty which is attributable to so 
much of the rate of the royalty which exceeds the lowest possible rate 
of the royalty at any subsequent time (disregarding any reductions in 
the rate of the royalty which are based solely upon changes in volume of 
production within a specified period of no more than 1 year). For 
example, assume that A creates a royalty with respect to a mineral 
property owned by A equal to 5 percent for 5 years and thereafter equal 
to 4 percent for the balance of the life of the property. An amount 
equal to 1 percent for 5 years shall be treated as a production payment. 
On the other hand, if A leases a coal mine to B in return for a royalty 
of 30 cents per ton on the first 500,000 tons of coal produced from the 
mine in each year and 20 cents per ton on all coal in excess of 500,000 
tons produced from the mine in each year, the fact that the royalty may 
decline to 20 cents per ton on some of the coal in each year does not 
result in a production payment of 10 cents per ton of coal on the first 
500,000 tons in any year. Another example of an interest which is to be 
treated as a production payment under this subparagraph is the interest 
in a partnership engaged in operating oil properties of a partner who 
provides capital for the partnership if such interest is subject to a 
right of another person or persons to acquire or terminate it upon terms 
which merely provide for such partner's recovery of his capital 
investment and a reasonable return thereon.
    (b) Property. The term property has the meaning assigned to it in 
section 614(a), without the application of section 614 (b), (c), or (e).
    (c) Transfer. The term transfer means any sale, exchange, gift, 
bequest, devise, or other disposition (including a distribution by an 
estate or a contribution to or distribution by a corporation, 
partnership, or trust).

[T.D. 7261, 38 FR 5465, Mar. 1, 1973]