It is the Government's position that, under IRC section 471(a), in order to
achieve the matching of income to expenses, the taxpayer is required to maintain
in inventory the gold extracted from the mining operation. This is necessary in
order to determine the income of the taxpayer. The matching of expense to income
follows the generally accepted accounting principal. A matching principal issue
generally arises when the taxpayer is in the production stage deducting expenses
related to the production phase of mining with little or no income. It is not
uncommon to examine a return where the taxpayer claims to be in production yet
keeps no inventory. Since the gold recovered must eventually be recognized as
income, inventories must be maintained.
The initial interview should establish when the taxpayer first went into
production and if any gold was on hand, either obtained with the claim or
produced in the exploration or development stages. The general rules of
inventory apply here, that is, how much gold was on hand at the beginning of the
year, how much was produced during the year, how much was sold, and how much was
on hand at the end of the year. This will provide the physical amounts used in
computing the cost-of-goods sold.
IRC section 471 establishes that an inventory must be kept. Treas. Reg.
section 1.446-1(a)(4)(i) recognizes the need for inventories and makes reference
to IRC sections 263A and 471. Treas. Reg. section 1.471-7 establishes the need
for inventories of miners and manufacturers and is supported by Treas. Reg.
section 1.61-3 which provides that in a manufacturing, merchandising, or mining
business, gross income means total sales less cost-of-goods sold. Cost-of-goods
sold should be determined in accordance with the method of accounting
consistently used by the taxpayer.
Treas. Reg. section 1.471-11(a) states that:
* * * In order to conform as nearly as possible to the best accounting
practices and to clearly reflect income (as required by section 471 of the
Code), both direct and indirect production costs must be taken into account in
the computation of inventoriable costs in accordance with the "full absorption"
method of inventory costing.
The Uniform Capitalization rules require the capitalization of the costs of
producing real and tangible personal property. See IRC section 263A(b)(1).
Mining operations involve the production of both real and tangible personal
property. Until the gold is extracted from the land, the taxpayer is engaged in
the production of tangible personal property. The gold is inventory in the hands
of the taxpayer.
The costs that must be capitalized are: (1) the direct costs, and (2) a
properly allocable share of the indirect costs that benefit or are incurred by
reason of the production of the mineral property. See IRC section 263A(2) and
Treas. Reg. section 1.263A-1(e)(3)(i). Treas. Reg. section 1.263A-1(e)(ii)
provides an illustrative list of indirect costs required to be capitalized. In
addition, IRC section 263A(f) requires the capitalization of interest incurred
with respect to the production of real property.
IRC section 263A(c)(3) provides that the general rules of IRC section 263A do
not require the capitalization of any cost that is allowable as a deduction
under IRC sections 263(c), 263(i), 291(b)(2), 616, or 617.
The direct and indirect costs that benefit or that are incurred by reason of
the production of the mineral property must be capitalized to that property. See
IRC section 263A(a)(1)(B). The direct and indirect costs that directly benefit
or are incurred by reason of the gold must be included in the inventoriable cost
of the gold. See IRC section 263A(a)(1)(A).
