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Rev. Rul. 77-247, 1977-2 CB 211

REV-RUL, Timber; disposal to parent; interest., Rev. Rul. 77-247, 1977-2 CB 211, (Jan. 01, 1977)

Section 631.--Gain or Loss in the Case of Timber, Coal, or Domestic Iron Ore

26 CFR 1.631-2: Gain or loss upon the disposal of timber under cutting contract.

[IRS Headnote] Timber; disposal to parent; interest.--
A subsidiary that has a contract with its parent providing that future timber cutting rights, which the subsidiary obtains on its own account, be immediately transferred to the parent is not the owner of an "interest in timber" within the meaning of section 631(b) of the Code with respect to cutting rights obtained after the date of the contract.

Advice has been requested whether, under the circumstances described below, a taxpayer owns an "interest in timber" within the meaning of section 631(b) of the Internal Revenue Code of 1954.

Z is a domestic corporation that uses logs as the raw material for manufacturing lumber and other wood products that it sells on the open market. The logs used are harvested by Z from timber standing on its own lands or from timber acquired by Z under various timber cutting contracts.

W is also a domestic corporation in the business of acquiring timber cutting contracts. After meeting the holding period requirements provided by section 631(b) of the Code, W disposes of the timber to other parties under contracts whereby W retains an economic interest in the timber within the purview of section 631(b) of the Code.

Z acquired W as its wholly owned subsidiary. W entered a contract with Z conveying to Z the right to cut the timber under all timber cutting contracts acquired by W during the next 15 years. The contract also provided that Z would pay for all the timber cut under the contracts at certain specified rates per unit of timber cut, subject to annual renegotiation. Z agreed to abide by all the terms of the various cutting contracts to be obtained by W during the next 15 years. However, the original grantors did not release W from responsibility for performance under each cutting contract.

After entering into the contract with Z, W obtained several timber cutting contracts. It immediately transferred the right to cut the timber to Z as required under the terms of the contract between W and Z. After the holding period provided for in section 631(b) of the Code was met, Z began to cut the timber and make payments to W therefore.

Section 631(b) of the Code provides that in the case of the disposal of timber held for more than 6 months (9 months for tax years beginning in 1977; 1 year for the tax years beginning after 1977) before such disposal, by the owner therefor under any form or type of contract by virtue of which such owner retains an economic interest in such timber, the difference between the amount realized from the disposal of such timber and the adjusted depletion basis thereof, shall be considered as though it were a gain or loss as the case may be, on the sale of such timber. For purposes of this subsection, the term "owner" means any person who owns an interest in such timber, including a sublessor and a holder of a contract to cut timber.

Section 1.631-2(e)(2) of the Income Tax Regulations provides that the provisions of section 631(b) of the Code apply only to an owner of timber. An owner of timber means any person who owns an interest in timber including a sublessor and a holder of a contract to cut timber. Such owner of timber must have a right to cut timber for sale on his own account or for use in his trade or business in order to own an interest in timber within the meaning of section 631(b).

Under the provisions of the contract between W and Z, W has attempted to dispose of all the future cutting contracts it will obtain in such a manner that the income therefrom will qualify for treatment under section 631(b) of the Code. In order for this income to qualify for such treatment, W must (1) be the owner of the timber, (2) have held the timber for the requisite period provided for in section 631(b) before its disposal, and (3) have provided for the disposal of the timber under some form of contract whereby W retains an economic interest in the timber.

In Manuel Schnitzer v. United States, Civil No. 67-252 (D. Ore. Dec. 10, 1968), the court stated that the taxpayers bought timber with the prior understanding that Georgia Mills would have the right to cut it. The indenture and the contract were treated as part of a single transaction. Georgia Mills would not have agreed to the indenture if the contract were not sure to follow. At no time did the taxpayers have the power to determine who would sever the timber from the land. They themselves could not have cut the trees. The taxpayers did not have the right to cut timber for sale on their own account or for use in their trade or business. They were not owners within the meaning of section 631(b) of the Code.

Accordingly, W is not the owner of the "interest in timber" within the meaning of section 631(b) of the Code with respect to the timber acquired under the timber cutting contracts obtained after it entered into the contract with Z for the disposal of timber because W never had the right to cut the timber on its own account as required by section 1.631-2(e)(2) of the regulations.

In the instant case, W obtained the cutting contracts in its name but, because of its contractual obligation to transfer the right to cut the timber to Z, any right W may have had to cut the timber on its own account was transitory and of no substance.