these changes is to preserve existing law with regard to this type of income. These statutory changes are required solely because of the changes made as to (domestic) personal holding company income.

Revenue effect

It is estimated that the personal holding company amendments will increase revenue $15 million a year. Generally the personal holding company provisions are made effective with respect to taxable years beginning after December 31, 1963.

SECTION 217. TREATMENT OF PROPERTY IN CASE OF OIL AND GAS WELLS

The percentage depletion deduction allowed an owner of an interest in oil and gas wells is measured by 27%1⁄2 percent of the gross income from his share of production but, if less, 50 percent of his net income from the "property." This net income limitation is important only to the operator who generally undertakes all of the business risks involved in the exploration, development, and operation of the property. Intangible drilling and development costs (on exploratory and development wells) are treated as business expenses deductible by him in reducing his share of the gross income from production (normally eight-eighths, if a fee owner-seven-eighths or less if a lessee) to his net income from the "property."

Under existing law he has the option to aggregate or combine any two or more operating mineral interests (regardless of tract boundaries, or the number of deposits) if they are within the statutory concept of an "operating unit"-treating any such aggregation as combined into a single "property," and treating each operating mineral interest (within the operating unit area) left out of such combination as a separate "property.' This option permits him to combine into a single "property" operating mineral interests having a high ratio of net income to gross income with those having a low ratio so that the 50 percent of net income limitation has little or no effect. This may be illustrated by considering the following aggregation of two properties involving separate deposits not in the same tract:

Before the 1954 act the term "property" by long-established interpretation was generally accepted as meaning each interest in each deposit in each separate tract or parcel of land (whether freehold or leasehold). Under this test (the 1939 code "lease" rule) only contiguous tracts or parcels, even if acquired by the same lease or deed, could be treated as a single tract or parcel of land. Similarly, each deposit in each tract or parcel of land was treated separately until (under early administrative practice) taxpayers were given the option (often

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it was difficult to determine how many deposits there were in a single tract) to aggregate or combine and treat as a single "property" the operating mineral interests in two or more separate deposits underlying a single tract or parcel of land. Those deposits not included in such aggregation were treated as separate properties.

By 1954 the soundness of these earlier technical limitations respecting the term "property" as applied to the hard minerals became doubtful where a single mining operation crossed tract (of land) boundaries to extract mineral deposits extending under adjacent or nearby tracts. In that year Congress, by adopting the "operating unit" test, allowed the aggregation or combination of such operating mineral interests in different properties operated as a unit to be treated as a single "property." In 1958 Congress adopted detailed rules in the case of hard minerals. Generally, they provided that operating mineral interests may be aggregated mine by mine and any number of mines may be aggregated so long as they are a single "operating unit." These rules applicable to hard minerals are left in force under the present bill.

The 1954 statutory change to the "operating unit" test of "property," though prompted by circumstances of the hard-mineral industry, was broad enough to include oil and gas wells. In that industry the operator function is commonly reduced for long periods of time to mere caretaking and maintenance carried on by the same crews without regard either to proximity of the wells or to the identity of the deposits or the geological relationship between them. Accordingly, there is no such well-defined "operating unit" as is evidenced by a single mining operation (though several mines may be involved) in the hard-minerals industry.

Also, unlike the mining industry, the oil and gas industry is allowed unlimited deductions against income from any source for intangible drilling and development costs. Generally, these deductions affect the percentage depletion allowance (through the net-income limitation) only by offsetting gross income to determine the net income of the property to which they relate for the year in which paid or accrued. Accordingly, the industry has for many years minimized the impact of these (often very substantial) deductions on percentage depletion by completing such exploratory and development drilling in years prior to any substantial production from the "property." The election under the 1954 aggregation rule must be exercised as respects a newly developed property in the first year in which such costs were incurred. Accordingly, such costs would enter into the netincome computation for limitation purposes as deductions against production income from all the operating interests then in the "operating unit." Apparently only the larger companies had a sufficiently high ratio of net income to gross income in aggregations elected under the 1954 rule (to deduct the often substantial exploratory and development drilling expenses of new properties added to such aggregation from time to time without materia ly reducing the percentage depletion deduction) to derive tax advanta e from the larger aggregations permitted under the "operating unit" test.

Another difference between the two industries made the 1954 aggregation provision less palatable to the oil and gas industry as a whole. Relatively few operating inter sts in mines are sold, whereas sales of such interests in oil and gas are common, especially by the

smaller independent companies. Their penchant for selling such interests in discoveries made shows their preference for the tax advantages available under the capital gain provisions. Since, as pointed out below, the sale of an operating interest included in an aggregation or combination of properties present allocation difficulties in the determination of the adjusted bases of those sold and those retained, those inclined to sell rather than to hold and produce had an added reason (avoidance of such difficulties) for not aggregating under the "operating unit" rule of the 1954 act.

In 1958 Congress gave oil and gas operators an option to use either the 1939 code "lease" rule preferred by the smaller operators or the 1954 code "operating unit" rule preferred by the larger companies. As pointed out above, the operating function in the case of oil and gas properties generally give little realistic substance to the "operating unit" test. Also the tax acvantages made available to those companies with a sufficiently large number of operating interest to take full advantage of that statutory concept of "property" gives them favored treatment. This combination of uncertainty of concept and specially favorable tax treatment creates a continuous controversy between taxpayers and the Government. Such controversy is aggravated by taxpayers' contentions that widespread areas (in some cases substantial portions of several States) form a single "operating unit." To remove this controversy and also to delete the favorable tax treatment available only to the larger companies the present bill restores the rule prevailing prior to the 1954 act. In substance, the 1939 code "lease" test of the term "property" is thus reinstated for all oil and gas cases for all taxable years beginning after December 31, 1963,

However, the bill changed the operational pattern of the option (available under the reinstated rule) to elect to combine or aggregate any two or more operating interests into a single "property. As above noted, such option (as initially developed treated each operating interest in each mineral deposit discovered in each tract or parcel of land as a separate "property" unless the taxpayer affirmatively elected to aggregate them. Any failure to so elect irrevocably precluded any future combination between properties so separated.

Generally, taxpayers prefer that such interests be aggregated. Accordingly, the bill recasts the option so that failure to affirmatively elect to the contrary automatically aggregates such interests as they are developed. If the taxpayer elects to treat separately the first two deposits discovered, he is thereafter committed to treat separately all later discovered deposits until he affirmatively elects to aggregate a new discovery with one of the prior discoveries. Once he has elected. to treat any discovery as aggregated with an earlier discovery, any discovery thereafter is automatically added to the aggregation unless the taxpayer affirmatively elects to treat the later discovery separately. Thus, as each discovery is made the taxpayer has a choice as to whether to include it in the existing aggregation or to treat it separately. Provision is also made for continuing any existing aggregation under the reinstated rule in the same manner as if created under this bill.

The bill also provides alternative methods of redetermining the adjusted bases, if any, of operating interests presently aggregated (under the "operating unit" rule of the 1954 code) that, under this

bill, must hereafter be treated separately. The basis of such aggregation (if any) may be allocated proportionately among the operating interests included therein in accordance with their fair market values. Also at taxpayer's option, he may use the adjusted basis of each such interest at the time it was first included in the aggregation, further adjusted to reflect adjustments reasonably attributable to such interest during the aggregation period, so that the total of such adjusted bases equals the adjusted basis of the former aggregation.

Finally, the bill contains several provisions dealing with issues arising from the unitization or pooling of oil and gas properties. Unitizations arise where two or more owners of operating mineral interests in separate tracts or parcels of land exchange (by cross-conveyances or contractual arrangements to share proportionately all exploitation costs and income) such interests for undivided interests in all the interests thus pooled. Similarly, a single operating lessee of a number of leases may unitize by arranging to pay his lessors royalties based on an undivided share of production income from all the leases.

Generally, the objective of unitization is to convert all of the operations exploiting a particular deposit into a single operation, thereby eliminating competition between rival operators and competing lessors, and the wasteful production efforts that often attend such rivalries. Thereafter better production methods may be consistently used throughout the remaining productive life of the deposit to get the greatest ultimate production from such deposit at the least possible cost. It has long been the general policy of the Federal and State Governments to encourage, if not require, unitization arrangements. Almost all wildcat areas are now pooled before development. Unitizations in already operating fields are aided by the fact that they are practical prerequisites to the application of secondary recovery projects which necessarily operate on the deposit as a unit. The bill excepts operating mineral interests (while included in unitized or pooling arrangements) from the effect of the above stated rules respecting the binding effect of elections exercised under the option to aggregate or treat separately the interests in the several deposits in a single tract or parcel of land and except as noted below, treats all operating mineral interests included by a taxpayer as one property for depletion purposes regardless of tract boundaries. This may result in a loss of depletion deductions where a taxpayer has for unitization one property with regard to which he takes cost depletion, and another property with regard to which he takes percentage depletion (because for example he has no remaining cost basis). This becomes obvious if we consider the unitization of the following two properties: