Question
February 2, 1996
BY HAND
Premerger Notification Office
Federal Trade Commission
Room 310
6th Street and Pennsylvania Ave., N.W.
Washington, D.C. 20004
Dear Dick:
Following up on our telephone conversation of Wednesday, this letter is intended to elaborate on my letter to you of January 30, 1996. Specifically, this letter sets forth additional information about the "production payment" that was described in my earlier letter.
For purposes of federal income taxes, Section 636 of the Internal Revenue Code treats a production payment as a mortgage interest. In other words, for income tax purposes, the grantor of the production payment is considered to have borrowed money from the grantee and the loan is deemed secured by a mortgage on the oil gas properties in question.
Under law, a production payment is a royalty interest, in this case in gas production. Although the holder of a production payment may have implied or contractual rights to cause the party that has the legal rights under the mineral lease to exploit and produce the mineral, the production payment interest alone does not entitle the royalty owner itself to conduct those exploration and production operations. Therefore, it is not a classic interest in real property, such as, for example, a co-tenancy, which would authorize each person to possess and occupy a piece of real estate.
As you and I discussed law provides that a production payment is considered to be a real property interest (i.e. a royalty); however, once the gas is produced from the well, then the severed gas constitutes personal property. There is case law in other states, however, that suggests that a production payment interest is other than a real property interest, perhaps, for example, a debt or an equitable lien.
The length of the production payment in the transaction at hand is measured by a volume of production; it is expected in this case to take approximately three years or a bit more in order to produce the share attributable to the production payment. When that volume of gas has been delivered, the production payment will terminate.
We greatly appreciate the attention you gave to our request for advice earlier this week. We are well aware of the great demands on the Premerger Office and your immediate response greatly assisted the parties to the transaction.
If you have any further questions, please call.
Sincerely,
[redacted]