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Notwithstanding Arkla's lack of an economic interest
in the mineral in place, petitioners argue that Congress
intended to apply "Section 636 loan treatment in all cases
without regard to whether the 'purchaser' acquired an
interest in the minerals which would constitute an
'economic interest' within the traditional meaning of the
term." Thus, petitioners take the position that Arkla's
right of recoupment under the Settlement Agreement is a
"production payment" within the meaning of section 636(a),
with the result that the consideration paid by Arkla under
the agreement is required to be treated as a mortgage loan.
We disagree.
Section 636 was added to the Internal Revenue Code by
the Tax Reform Act of 1969, Pub. L. 91-172, sec. 503(a), 83
Stat. 487, 630. In order to address petitioners' argument
that section 1.636-3(a)(1), Income Tax Regs., is invalid,
it is necessary to review the tax treatment of production
payments prior to the passage of section 636.
Before section 636 became law, the owner of a mineral
property who sold, or carved out, a portion of his future
production was required to treat the consideration received
for the production payment as ordinary income, subject to
depletion, and to include such amount in income in the year
received. Commissioner v. P.G. Lake, Inc., 356 U.S. 260
(1958). The courts had adopted the Commissioner's view
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