22 T.C. 1075">*1075 The respondent determined deficiencies in income tax against petitioner for the years 1947 and 1948 of $ 1,842.34 and $ 32,802.40, respectively. The question for decision is whether the excess of expenditures by petitioner in respect of its Mine No. 4, over the net receipts from1954 U.S. Tax Ct. LEXIS 121">*123 coal sold, is deductible as operating expenses or chargeable to petitioner's capital account under section 29.23 (m)-15 of Regulations 111.

FINDINGS OF FACT.

Petitioner, a corporation with its principal office at Middlesboro, Kentucky, is engaged in the mining of coal and has been so engaged 22 T.C. 1075">*1076 since 1905. Prior to 1922, it was incorporated as the Clear Fork Coal and Coke Company, a Delaware corporation. In that year, it was reincorporated under its present name as a Kentucky corporation. Its income tax returns for the years involved were filed with the collector of internal revenue for the district of Kentucky.

Petitioner opened its first mine, Mine No. 1, in 1905, and extracted coal therefrom until January 1947. Mine No. 2 was opened in 1924 and operated until 1940. Mine No. 3 was opened in 1937, and was still in operation at the time of this proceeding. Mine No. 4 was opened in 1944 and continued until July of 1951. Mine No. 5, an extension of Mine No. 1, was begun in 1947, and operations lasted about a year. These mines were in the Mason, Sterling, and Jellico seams of coal located in Logan Mountain, in the Cumberland Range, near Middlesboro, Kentucky.

Mine No. 1954 U.S. Tax Ct. LEXIS 121">*124 4 was opened into the so-called Jellico seam, which was a strata of coal existing in a 30 to 40 square mile area in southeastern Kentucky and northeastern Tennessee. Other mining companies had mines in the Jellico seam and the nature and quality of the coal, its thickness, and ceiling conditions were generally well known before Mine No. 4 was started. Petitioner's officers shared this knowledge. Approximately 2 years prior to the opening of Mine No. 4, bore holes and geological surveys were made to determine the exact conditions of the Jellico seam in that immediate area. As a result of the information gathered from these drillings and surveys, it was determined that the seam varied in thickness from 32 inches to 38 inches, above which there was a layer of soft shale 24 inches to 40 inches thick. Over the shale was a 6-inch rider seam of coal and then a layer of sandstone. On the basis of this information, petitioner laid out plans for developing and working Mine No. 4 by the "room and pillar" method of mining.

In the room and pillar method of mining coal, headings or entryways are driven into the seam for the purpose of exposing the main body of coal and rooms are then turned1954 U.S. Tax Ct. LEXIS 121">*125 off at right angles to these entryways into the exposed coal. The entryways in Mine No. 4 were 13 or 14 feet wide and were driven through the main seam of coal. In driving the entryways the shale and rider seam as well as the layer of coal were removed. This was done in order that there would be a sandstone ceiling overhead which weathered better, was more easily maintained, and was safer than shale; it also provided more headroom and working space for the operations which thereafter were to be conducted and carried on through the entryways. The entryways contained tracks for the coal cars and electric power lines required for the operation of the machinery and the removal of the coal from the mine. Airways, driven about 20 feet to the side and parallel to 22 T.C. 1075">*1077 the entryways, were also 13 or 14 feet wide and provided the necessary ventilation for the mine. In most instances, there was an airway on each side of the entryway. In driving the airways only the main seam of coal was removed so that they were only 32 to 38 inches high and had soft shale ceilings, which occasioned frequent falls. Because they were only used for ventilation purposes, the airways were not heavily1954 U.S. Tax Ct. LEXIS 121">*126 timbered for support. If small ceiling falls occurred in the airways they were not moved, and larger ceiling falls were merely spread out so that the airways were kept sufficiently clear in order to get the free circulation of air. The rooms were turned off at right angles to the entryways and airways. The rooms were about 12 feet wide at the neck where they turned off the entryway and then funneled out and increased in width to 25 or 27 feet; they were about 250 to 300 feet deep and, as in the case of the airways, only the main seam of coal was taken from the rooms. Due to the nature of the shale overlay above the coal, rooms could not be turned from an entryway at a given point so long as the entryway was required to reach and remove the coal from beyond that point. The turning of rooms and the mining of the coal would have resulted in cave-ins and the further use of entryways would have been lost. As a consequence, it was necessary to mine coal in Mine No. 4 by the "retreat" method. By that method, the entryway was driven as far as it was desired it should go before any rooms were opened from it, and it was at that point that the first rooms would be opened and mined, with1954 U.S. Tax Ct. LEXIS 121">*127 new rooms being opened and mined as the operation retreated toward the mouth of the entryway.

The portal to Mine No. 4 was opened in 1944 and an entryway was driven from the portal in a southeasterly direction, which entryway at a point about 800 feet from the portal was designated as 1-South. At the same point, the driving of a second entryway, 1-West, which was to run at a right angle and in a southwesterly direction from 1-South, was begun. This point was reached at or about the end of 1944 or the beginning of 1945. During 1945 and 1946 entryway 1-West and an accompanying airway were extended for only a short distance, the plan then being to continue with entryway 1-South and at intervals of approximately 600 feet to drive cross-entryways therefrom in a southwesterly direction parallel to 1-West and at right angles to 1-South, and to begin the mining of coal from rooms turned from these cross-entryways. The first such cross-entryway was designated 1-Left, and the others were to be designated 2-Left, 3-Left, and so on. During 1945 the driving of cross-entryway 1-Left was begun. Rooms were turned near its mouth and coal was mined therefrom. The turning of these rooms and the1954 U.S. Tax Ct. LEXIS 121">*128 mining of coal from them was "an adventure, to see what would happen." The experiment demonstrated 22 T.C. 1075">*1078 that the conditions of and above the coal seam were such that the rooms could not be turned and the coal mined as the driving of the entryway progressed, but that the mining would have to be done by the retreat method, as described above. The turning of the rooms and the mining of the coal therefrom were accordingly suspended until entryway 1-Left could be driven for a distance of approximately 1,000 feet, at which point the mining of the rooms by the retreat method would begin. During most of 1945 petitioner was occupied in driving entryway 1-South and its accompanying airways to and a short distance beyond the point at which cross-entryway 1-Left would be turned and in the driving of entryway 1-Left and its accompanying airways toward the point in the main body of the coal at which the turning of rooms was to begin. Except for an insignificant amount of work done on 1-West, some limited extension of 1-South, and the completion of 1-Left to the depth of 1,000 feet, all of 1946 was devoted to the turning of rooms and the mining and removing of the coal along 1-Left, by 1954 U.S. Tax Ct. LEXIS 121">*129 the retreat method, and by the end of that year the mining of the rooms, back to and including the experimental rooms which had been turned near the mouth of the entryway in 1945, had been completed.

Early in 1947, when entryway 1-South was at the point at which cross-entryway 2-Left was to be turned, certain natural difficulties were encountered. Faults were found to exist in the seam which, in the judgment of petitioner's officials, made it impracticable to proceed further. The bed of coal pitched or slanted to such an extent that the shaker conveyor being used would not shake the coal up the grade. Excessive water was encountered and roof conditions were found to be unusually bad. Because of these adverse conditions, petitioner decided to proceed no further with its originally projected plan of going forward with entryway 1-South.

When the plan for extending entryway 1-South was dropped, petitioner removed its machinery to entryway 1-West and began extending 1-West and an accompanying airway. At approximately 300 feet from 1-South, it also drove an entryway and an accompanying airway in a northwesterly direction to the outcrop, at which point a fan was installed for the purpose1954 U.S. Tax Ct. LEXIS 121">*130 of providing added ventilation for the mine. The accumulation of water and other difficulties had reduced the effectiveness of a ventilation outlet which had been driven near the mine portal in 1945. By the end of 1947, entryway 1-West had been extended approximately 2,200 feet from its intersection with 1-South, and at 2,000 feet an entryway, with accompanying airways, designated 2-South and running parallel to 1-South, had been turned at a right angle from 1-West. During all of 1947 petitioner was wholly occupied with the driving of the entryways as described. It 22 T.C. 1075">*1079 did no room mining and actually mined and removed only such coal as was in the path of the entryways and airways being driven chiefly along 1-West and from 1-West to the outcrop, where the fan was placed.

During 1948 petitioner devoted its full time to the further driving of entryways and the accompanying airways. It extended 1-West for a further distance of approximately 1,400 feet. It drove 2-South for a distance of 1,200 feet, to a point at which cross-entryway 2-Left was to be turned for the purpose of the room mining of coal. It drove cross-entryway 1-Left from 2-South in a northeasterly direction1954 U.S. Tax Ct. LEXIS 121">*131 to the approximate point at which that entryway had been driven from 1-South in 1945 and 1946 and the room mining of coal had begun. Some machinery became available from another mine and was set up in 1-South in a further effort to extend that entryway. Petitioner did succeed in turning and driving entryway 2-Left for approximately 200 feet, and in 1949 that entryway was further extended approximately 300 feet and utilized for the room mining of coal. It was not possible, however, to overcome the difficulties encountered in the efforts to extend entryway 1-South, and in 1948 all plans for any further extension of 1-South were definitely and finally abandoned. As in 1947, petitioner in 1948 did no room mining of coal and the only coal mined and removed was that which was in the entryways and airways driven as outlined.

The cost of driving the entryways and accompanying airways, and which included the mining and removing of the coal therefrom, was substantially greater than that of mining and removing comparable quantities of coal from rooms.

By reason of the necessity for the mining of coal by the retreat method, as demonstrated by petitioner's experience in 1945, and due to the1954 U.S. Tax Ct. LEXIS 121">*132 fact that natural difficulties which were encountered forced the abandonment of its originally projected plan of extending entryway 1-South, the driving of entryways 1-West and 2-South and their maintenance for entry to and the removal of coal lying to the southwest of 1-South became a necessity and those entryways had to be driven and established before petitioner's projected plan for the room mining of the main body of the coal could be accomplished. They were the only means for the opening up for mining of the coal along cross-entryways 1-Left, 2-Left, 3-Left, and 4-Left, and other cross-entryways which might be driven from 2-South or any extension thereof. In short, they were part and parcel of the facilities constructed or developed for the subsequent mining of such coal, and being main entryways, they could not be utilized for the room mining of the coal adjacent to them until the areas beyond had been worked. To do otherwise, would have resulted in cave-ins and the closing not only 22 T.C. 1075">*1080 of these main entryways but the mine beyond. In the driving of these entryways, the production of the coal removed was of secondary importance. The primary objective was the construction1954 U.S. Tax Ct. LEXIS 121">*133 or setting up of the facilities for the subsequent mining and removing of the main body of the coal by the room and pillar and the retreat methods of mining.

Thereafter, in 1949 and 1950, with the exception of the extension of 2-South from 3-Left to 4-Left and the driving of the cross-entryways 2-Left, 3-Left, and 4-Left for various distances, petitioner's activity was wholly that of the room mining of coal from rooms along cross-entryways 1-Left, 2-Left, and 3-Left.

In 1951, Mine No. 4 was closed as an unprofitable operation.

The production figures for petitioner's Mine No. 4 from 1945 to 1950, inclusive, are as follows:

On its income tax returns, petitioner reported losses on Mine No. 4 of $ 91,013.99 for 1947 and $ 54,750.87 for 1948. Respondent disallowed the deduction of these losses and determined the mine to be in the development stage, and that the expenditures in excess of net receipts were to be capitalized under section 29.23 (m)-15 of Regulations 111 and recoverable through depletion.

Petitioner suffered a net loss of 1954 U.S. Tax Ct. LEXIS 121">*134 $ 80,698.69 in 1949, and having reported a net loss for 1947 of $ 9,174.76, it claimed, in making its return for 1949, a net operating loss carry-back from 1949 to 1948, for which year it had reported a net income of $ 48,296.03. The respondent's determination for 1947 being that petitioner's net income was $ 82,733.17, he has applied the 1949 net operating loss carry-back against 1947 net income in his determination of deficiencies herein. In making the carry-back to 1947, however, he reduced the $ 80,698.69 net loss for 1949 by $ 6,410.49, described as "Percentage depletion in excess of cost -- 1947." Petitioner claimed percentage depletion of $ 2,115.77 as to Mine No. 3 and cost depletion of $ 5,469.64 as to Mine No. 4 on its 1947 return, a total depletion allowance claimed of $ 7,585.41.

OPINION.

Simply stated, the question is whether during the years 1947 and 1948 petitioner's Mine No. 4 was in a "development stage," or in "a producing status," within the meaning of section 29.23 22 T.C. 1075">*1081 (m)-15 of Regulations 111. ¹ By that regulation, it is provided that "All expenditures in excess of net receipts from minerals sold shall be charged to capital account recoverable through1954 U.S. Tax Ct. LEXIS 121">*135 depletion while the mine is in the development stage," and further, that "The mine will be considered to have passed from a development to a producing status when the major portion of the mineral production is obtained from workings other than those opened for the purpose of development, or when the principal activity of the mine becomes the production of developed ore rather than the development of additional ores for mining." The regulation is one of long standing, and both parties accept its validity.

1954 U.S. Tax Ct. LEXIS 121">*136 While the term "development" has not been given a precise definition under the regulations or in the cases decided, and may not be susceptible of such a definition, it has been held that its use "is not restricted to 'discovery' or 'exploration,'" and further, that a mine, though previously and for an extended period in a production status, may again be in the development stage within the meaning of the regulation, even though the new development was not that of other or newly discovered bodies of ore but of ore bodies which previously had been worked. Guanacevi Mining Co. v. Commissioner, 127 F.2d 49, affirming 43 B. T. A. 517. See also Alsted Coal Co. v. Yoke, 200 F.2d 766. In the Guanacevi case, the question was as to the deductibility as operating expenses of the cost of driving two new tunnels into known bodies of ore "which previously had been worked near the surface" but in which production had been suspended because the previously developed high grade ore had been exhausted and the driving of the two new tunnels was essential and necessary to the subsequent mining of the1954 U.S. Tax Ct. LEXIS 121">*137 remaining low grade ore, which a survey had indicated could be mined at a profit. As in the instant case, substantial quantities of ore were produced in each of the years involved, and the argument advanced by the taxpayer was substantially the same as the argument of the petitioner here. There it was argued "that the cost of the tunnels was an operating expense deductible in 22 T.C. 1075">*1082 the year in which the ore was extracted and sold, that petitioner was operating a mine which was past the development stage; that the mine was on a strict production basis; that the tunnels were driven solely for extraction (as distinguished from discovery) of known and prevalued ores." Holding that the cost of the tunnels was development expenses within the meaning of the regulation, the court said:

The tunnels made available these ores which were theretofore inaccessible. It follows that the expenditures in question were made for the purpose of attaining an output, not of maintaining an output, and were, therefore, "development" expenses, properly chargeable to capital, to be recovered through depletion deductions. * * *

In support of its conclusion, the court cited Blockton Cahaba Coal Co. v. United States, 24 F.2d 180, 181.

1954 U.S. Tax Ct. LEXIS 121">*138 In our opinion, the same conclusion is required in the instant case. There are some factual differences, but they are not distinguishing differences. By reason of petitioner's inability to mine the adjacent coal as the driving of the entryways progressed, due to ceiling conditions, it could mine the coal only by the retreat method of mining after the entryway had been driven to a fixed or predetermined point, and because of its inability to extend entryway 1-South and thereby turn cross-entryways to enable it to do such mining, it was, for all practical purposes, as effectively cut off from its main ore body as was true in the Guanacevi mine, and before it could again resume a production status it was an essential and a prerequisite that the new system of entryways be driven and completed.

It is, of course, true that throughout 1947 and 1948 petitioner was producing substantial amounts of coal from the entryways and the accompanying airways, but that was only a part of the operation. Large amounts of shale above the coal seam were removed to provide headroom and secure a firm ceiling for the subsequent use of the entryway. Tracks were laid and wiring installed not merely for the1954 U.S. Tax Ct. LEXIS 121">*139 removal of the coal thereafter to be taken from the entryways and the accompanying airways, but to provide a permanent avenue for the removal of coal from the rest of the mine. The regulation obviously takes into account the fact that while the mine is in the development stage there will most likely be some production of coal and that after the mine has passed from development to a producing status some development work will be necessary to maintain normal production, but incidental development work carried on while a mine is in a producing status will not, under the regulation, cause the mine to be considered to be in the development stage, nor will incidental production while the mine is in the development stage require that the mine be considered to be in a producing status.

The evidence shows, and we have found as a fact, that during 1947 and 1948 the production of coal was secondary to the primary objective 22 T.C. 1075">*1083 of constructing or setting up the facilities for the subsequent mining and removing of the main body of the coal, namely, the driving of entryways and the accompanying airways. During those years petitioner had turned its available manpower and machinery to the1954 U.S. Tax Ct. LEXIS 121">*140 driving of the entryways, in order to attain or achieve a position from which its room mining of coal could be resumed. It follows, we think, that the expenditures incurred in driving and completing the entryways were made for attaining an output of coal from the main body of ore, and not for the purpose of maintaining an output which had already been attained. Guanacevi Mining Co. v. Commissioner, supra. See also Connellsville Central Coke Co., 27 B. T. A. 771.

The work done in 1947 and 1948 was that of developing additional ores for mining, both in fact and within the meaning of the regulations, and the respondent did not err in his determination that the expenditures in those years which were in excess of net receipts from the coal sold should be charged to petitioner's capital account and be recoverable through depletion.

Decision will be entered under Rule 50.