Royalty income issue. -- It is petitioner's primary contention that its agreement with Jamieson Co. effected a sale of its entire interest in the sand and gravel deposits, the proceeds of which were capital gains rather than royalties. On this basis it reasons that the income from that sale was not a part of its ordinary gross income and therefore did not contribute either to adjusted 64 T.C. 510">*519 ordinary gross income or to personal holding company income. The parties agree that if the proceeds were capital gain, petitioner is not subject to the personal holding company tax because it failed to meet the 60-percent requirement upon which classification under section 542(a)(1) as a personal holding company is predicated. The Commissioner, however, takes exception to petitioner's conclusion as to the nature of the sand and gravel income. It is the Commissioner's contention that this was ordinary income1975 U.S. Tax Ct. LEXIS 120">*143 derived from mineral royalties. It therefore constituted ordinary gross income, and, because it was mineral royalty income, it also entered into the computation of both adjusted ordinary gross income under section 543(b)(2)(B) and personal holding company income by reason of section 543(a)(3).

Alternatively, petitioner takes the position that, for the taxable years ended in 1967 and 1969, even if the proceeds in question were mineral royalties, petitioner otherwise met the three conditions of section 543(a)(3) for which reason the mineral royalty income was not includable in its personal holding company income, and its remaining personal holding company income did not amount to 60 percent of its adjusted ordinary gross income. In this regard, petitioner argues that the California franchise and real property taxes which it paid were not "deductions which are specifically allowable under sections other than section 162," as provided in section 543(a)(3)(C)(ii), with the result that its section 162 deductions exceeded 15 percent of its adjusted ordinary gross income, even including the mineral royalties. The Commissioner here disputes not only the mathematics involved in petitioner's1975 U.S. Tax Ct. LEXIS 120">*144 allocation of such taxes, but more basically, he denies that they fell beyond the reach of section 543(a)(3)(C)(ii) inasmuch as they were specifically deductible by reason of section 164. We hold in favor of the Commissioner.

Whether a taxpayer is entitled to capital gains treatment upon the sale of sand, gravel, and the like is a familiar question with which the courts have wrestled seemingly all too often. From the plethora of opinions on this subject has emerged the now widely accepted principle by which the facts of each case are to be measured. Often referred to as the "economic interest" test, it was first propounded by the Supreme Court in Palmer v. Bender, 287 U.S. 551">287 U.S. 551, with respect to the depletion allowance for oil and gas. In order to be eligible for that deduction, the taxpayer must 64 T.C. 510">*520 have held an economic interest in the mineral property, the required evidence of which was that the taxpayer (1) acquired an interest therein through investment, and (2) secured income derived solely from the mineral extraction "to which he must look for a return of his capital." 287 U.S. 551">287 U.S. at 557.

The extension of this criterion1975 U.S. Tax Ct. LEXIS 120">*145 to the taxation of proceeds from the extraction of hard minerals may be stated as follows: if the property owner disposes of his entire interest in the deposits "in place," unconditionally and without further interest in their removal, then his income therefrom is not disqualified from being regarded as capital gain by reason of the form of the transaction; however, where the terms of the agreement are tantamount to a lease for the exploitation of the land whereby the property owner must look to the extraction of the mineral in order to recover his capital, then the owner has retained an economic interest in the deposits and in their production which interest renders the gain reflected in the proceeds therefrom ordinary income in his hands. Alkire v. Riddell, 397 F.2d 779, 780 (9th Cir.); Hair v. Commissioner, 396 F.2d 6, 8 (9th Cir.), affirming a Memorandum Opinion of this Court; Hartman Tobacco Co. v. United States, 471 F.2d 1327, 1329-1330 (2d Cir.); Laudenslager v. Commissioner, 305 F.2d 686, 690-691 (3d Cir.), affirming a Memorandum Opinion of this 1975 U.S. Tax Ct. LEXIS 120">*146 Court; Cox v. United States, 497 F.2d 348, 350 (4th Cir.); Wood v. United States, 377 F.2d 300, 304-305 (5th Cir.), certiorari denied 389 U.S. 977">389 U.S. 977; Gitzinger v. United States, 404 F.2d 191, 193 (6th Cir.); Schreiber v. United States, 382 F.2d 553, 554 (7th Cir.); Dingman v. United States, 429 F.2d 70, 72 (8th Cir.); Samuel L. Green, 35 T.C. 1065">35 T.C. 1065.

Where, as here, it is not disputed that petitioner acquired an interest in the deposits through investment, the key consideration is the basis upon which it recouped that investment, or stated otherwise, did petitioner "look solely to the extraction of * * * [minerals] for a return of * * * [its] capital." Commissioner v. Southwest Expl. Co., 350 U.S. 308">350 U.S. 308, 350 U.S. 308">314. If so, then the proceeds were royalties as that term is defined in the regulations and by this Court. Sec. 1.543-1(b)(3), Income Tax Regs.; U.S. Universal Joints Co., 46 B.T.A. 111">46 B.T.A. 111, 46 B.T.A. 111">116.

The answer to the1975 U.S. Tax Ct. LEXIS 120">*147 question depends largely upon an evaluation of the particular facts involved. Moreover, as in tax matters of every sort, unless otherwise clearly provided by statute, we must 64 T.C. 510">*521 be guided by the substance of the underlying arrangement, not by its formal trappings. Commissioner v. P.G. Lake, Inc., 356 U.S. 260">356 U.S. 260, 356 U.S. 260">266-267; Rutledge v. United States, 428 F.2d 347, 352 (5th Cir.); Royalton Stone Corp. v. Commissioner, 379 F.2d 298, 299 (2d Cir.), affirming a Memorandum Opinion of this Court; Estate of Ollie G. Rose, 56 T.C. 185">56 T.C. 185, 56 T.C. 185">190. And in applying these principles to the present problem, "The determination of whether an economic interest has been retained is not dependent upon the label that is given to the transaction by the parties." Laudenslager v. Commissioner, 305 F. 2d at 690. Thus, "[the] economic interest test is not affected by the fact that the agreement was written as a sale rather than as a mineral lease." Hartman Tobacco Co. v. United States, 471 F. 2d at 1329.

The substance of 1975 U.S. Tax Ct. LEXIS 120">*148 the arrangement between petitioner and Jamieson Co. convinces us that petitioner did retain an economic interest in its sand and gravel deposits for which reason the payments received from Jamieson Co. are royalties. Although the parties adopted the language of an outright sale in one portion of their agreement, this was nothing more than protective coloration, and was contradicted by other provisions therein. The heart of their arrangement was contained in the terms of paragraph 3, where they provided that Jamieson Co. was to pay petitioner a specified amount for each ton of rock, gravel, or sand removed. This was the only consideration for the sand and gravel. Moreover, the amount so specified was based on a sliding scale of prices per ton pegged to the average wholesale price during the month of removal. Accordingly, the agreed-upon payments to petitioner were entirely dependent upon Jamieson Co. removing the sand and gravel. The contract provided for no downpayment, no guaranteed minimum payment, no ceiling on payments, and no other compensation. Cf. United States v. White, 311 F.2d 399 (10th Cir.); Gowans v. Commissioner, 246 F.2d 4481975 U.S. Tax Ct. LEXIS 120">*149 (9th Cir.); Don C. Day, 54 T.C. 1417">54 T.C. 1417. Indeed, by tying the price of the sand and gravel to current market conditions, the agreement underscored petitioner's ongoing stake in the extraction and sale of those deposits. We can hardly imagine a clearer instance of a retained economic interest. The only real sales occurred as the gravel was severed from the land ton by ton and paid for at a price geared to current market conditions. There was no sale of the material "in place" at the time of execution of the agreement.

64 T.C. 510">*522 Our conclusion in this respect is confirmed, we think, by the language of the 1962 addendum to the contract which provided that the "purchase price" would be reduced by 20 percent in any year in which petitioner "sold" more than a million tons of rock, sand, and gravel to Jamieson Co. By its agreement to this price reduction as an incentive for Jamieson Co.'s increased production, petitioner attested to the explicitly conditional nature of its recovery of its investment. Plainly, it was the parties' understanding that their arrangement involved continuing and repeated royalty payments in respect of the sand and gravel as they1975 U.S. Tax Ct. LEXIS 120">*150 were removed rather than a single, unconditional sale of the deposits "in place" to be paid for either in a lump sum or by installments.

Petitioner nonetheless argues that Jamieson Co.'s obligation under the contract to remove all of the deposits on petitioner's land was unconditional and enforceable in court, as a result of which petitioner would have us conclude that the payments under the contract were not dependent upon the extraction as such but were rather in the way of installments on a single purchase price which, on account of the uncertain extent of the deposits, could not be ascertained at the outset.

This interpretation of the contract, however, fails to account for the percentage-of-market price arrangement and for the agreement to grant Jamieson Co. production discounts, both of which smack of a retained economic interest by petitioner. The broader response to petitioner's position, though, is that nowhere in the contract was Jamieson Co. obligated to remove any deposits. To be sure, it was contemplated that it would remove some deposits. The contract included an estimate of available deposits, qualified, however, by a specific disclaimer of any warranty in respect1975 U.S. Tax Ct. LEXIS 120">*151 thereof. But paragraph 1 spoke only of a "right" to quarry on the premises, and then only "as may be proper and profitable under good quarrying practices." Furthermore, paragraph 4 provided Jamieson Co. with an option to terminate the agreement if "at any time * * * Buyer determines that rock, gravel and sand can no longer be profitably quarried and removed from the lands." This is not the language of an unconditional obligation. Cf. Estate of Walker v. Commissioner, 464 F.2d 75 (3d Cir.); Royalton Stone Corp. v. Commissioner, 379 F.2d 298 (2d Cir.). Quite the contrary, by reason of this escape clause, petitioner's prospect of receiving payments 64 T.C. 510">*523 was wholly dependent upon Jamieson Co. determining that market conditions were favorable. This circumstance alone, apart from other considerations, serves to distinguish this case from Wayman A. Collins, 56 T.C. 1074">56 T.C. 1074, upon which petitioner relies. Even with respect to the estimated deposits, it is clear that their actual presence or absence was immaterial insofar as Jamieson Co.'s obligation to mine them was concerned.

In this regard1975 U.S. Tax Ct. LEXIS 120">*152 it appears to us that petitioner's true role in this arrangement was that of a costakeholder with Jamieson Co. in the deposits, both of whom bore the risk of a poor market and shared the gains in a favorable market. The contingent nature of petitioner's compensation resembled the situation in Hair v. Commissioner, 396 F.2d 6 (9th Cir.), in which the purchaser was not obligated to remove all of the sand and gravel from the property. On that basis the Court distinguished the situation with which it had dealt in Gowans v. Commissioner, supra at 8-9, concluding that:

Where, as here, taxpayers [sic] only substantive return of capital is dependent upon a unit price payment for an undetermined amount of sand and gravel, to be paid if, as, and when removed, they have retained an economic interest. * * * [Emphasis supplied.]

See also Alkire v. Riddell, 397 F.2d 779, 780 (9th Cir.).

By reason of the conditional payment arrangement here and the absence of an obligation of Jamieson Co. to remove all, or indeed any, of the sand and gravel deposits, we are fully persuaded that under the agreement petitioner looked solely1975 U.S. Tax Ct. LEXIS 120">*153 to the extraction of the deposits for a return of its investment in the land. Petitioner thus retained an economic interest in the property in the form of royalty payments, the fact of which belies the existence of a sale of the deposits "in place." This conclusion in respect of the form of the transaction relieves us of the necessity of deciding whether the sand and gravel deposits could properly be deemed a capital asset in the hands of petitioner, although the answer seems fairly clear since the corporation was engaged in the business of selling sand and gravel. Cf. Corn Products Co. v. Commissioner, 350 U.S. 46">350 U.S. 46. On account of the foregoing, we hold that petitioner's gross income from such sales was properly reported by petitioner as ordinary income and that petitioner is therefore not entitled to a refund. Accordingly, its income from gravel sales was includable in the computation of its ordinary gross income and its adjusted ordinary gross income 64 T.C. 510">*524 under section 543(b)(1) and (2). It is also includable in petitioner's personal holding company income under section 543(a)(3) unless petitioner has met the terms of the cumulative three-part1975 U.S. Tax Ct. LEXIS 120">*154 exception contained therein.

To repeat, under the pertinent statutory provision of section 543(a)(3), personal holding company income means the portion of adjusted ordinary gross income which consists of, among other items,

(3) Mineral, oil, and gas royalties. -- The adjusted income from mineral, oil, and gas royalties; except that such adjusted income shall not be included if --

(A) such adjusted income constitutes 50 percent or more of the adjusted ordinary gross income,

(B) the personal holding company income for the taxable year (computed without regard to this paragraph, * * *) is not more than 10 percent of the ordinary gross income, and

(C) the sum of the deductions which are allowable under section 162 (relating to trade or business expenses) other than --

equals or exceeds 15 percent of the adjusted ordinary gross income. [Emphasis supplied.]

The parties agree that petitioner did not in any event comply with the 10-percent test of part (B) for the taxable year ended in 1968. Furthermore, 1975 U.S. Tax Ct. LEXIS 120">*155 unless petitioner was entitled to include its California franchise and real property taxes in its computations under (C), it cannot avail itself of the exception for the remaining 2 years in issue. The California franchise tax is a tax levied on net income, Cal. Rev. & Tax. Code, sec. 23151 (West 1970), and is specifically deductible under section 164(a)(3) of the Code; State property taxes are specifically deductible under section 164(a)(1). Therefore neither tax may be considered for purposes of the test under section 543(a)(3)(C). Thus, regardless of whether petitioner otherwise satisfied the conditions of section 543(a)(3)(A) and (B) for the taxable years ended in 1967 and 1969, we hold that it failed to meet the requirement of part (C) in both years.

Petitioner's reliance on our decision in McNutt-Boyce Co., 38 T.C. 462">38 T.C. 462, affirmed 324 F.2d 957 (5th Cir.), is misplaced inasmuch as Congress prospectively reversed the result reached in 64 T.C. 510">*525 1964. Sec. 225(c), Revenue Act of 1964, Pub. L. 88-272, 78 Stat. 19, 80-81. See H. Rept. No. 749, 88th Cong., 1st Sess. A92. Likewise, section 543(a)(3), formerly section 543(a)(8), 1975 U.S. Tax Ct. LEXIS 120">*156 was amended at that time by the introduction of the language now contained in (C)(ii). Sec. 225(d), Revenue Act of 1964, Pub. L. 88-272, 78 Stat. 19, 82. See H. Rept. No. 749, 88th Cong., 1st Sess. A95. Cf. ibid. at A97, with respect to similar language added to section 543(a)(4)(C). The statute is now too clear with respect to the exception to require further discussion. We therefore conclude that because the exception provided in section 543(a)(3) is not available to petitioner, ⁹ there is no reason not to include its adjusted income from mineral royalties in its personal holding company income, as a result of which petitioner is a personal holding company within the meaning of section 542(a) for all 3 of the years here involved and is subject to the tax imposed by section 541.

1975 U.S. Tax Ct. LEXIS 120">*157 Procedural issues. 1. Statute of limitations. -- Petitioner nonetheless maintains that collection of the deficiencies determined by the Commissioner is barred by reason of the Commissioner's disregard of two procedural requirements. The first of these alleged errors pertains to the mailing of the notice of deficiency, which, petitioner points out, occurred more than 3 years after January 16, 1970, the date on which it filed its return for the most recent of the years in issue. Petitioner concludes that the assessment and collection of the deficiencies herein is barred by section 6501(a), ¹⁰ the applicability of which to personal holding company taxes, says petitioner, is not affected by petitioner's consent to an extension of the period of limitation upon the assessment of "income and profits tax."

1975 U.S. Tax Ct. LEXIS 120">*158 The short answer to petitioner's position is that the applicability of section 6501(a) is expressly subject to the other provisions of section 6501, among which is the following:

64 T.C. 510">*526 (f) Personal Holding Company Tax. -- If a corporation which is a personal holding company for any taxable year fails to file with its return under chapter 1 for such year a schedule setting forth --

(1) the items of gross income and adjusted ordinary gross income, described in section 543, received by the corporation during such year, and

(2) the names and addresses of the individuals who owned, within the meaning of section 544 (relating to rules for determining stock ownership), at any time during the last half of such year more than 50 percent in value of the outstanding capital stock of the corporation,

In each of the years in issue petitioner filed a standard U.S. Corporation Income Tax Return, Form 1120, unaccompanied by the schedule of specific information referred1975 U.S. Tax Ct. LEXIS 120">*159 to in section 6501(f). Petitioner nevertheless contends that section 6501(f) is inapplicable because all of the information sought therein was contained in petitioner's returns, albeit not on a separate schedule. This position is simply untenable.

In the first place, nowhere did petitioner provide the Commissioner with its adjusted ordinary gross income or even all the information necessary for its computation. ¹¹ This particular item was considered to be of sufficient importance that its specific mention was added to section 6501(f) by amendment in 1964. Revenue Act of 1964, Pub. L. 88-272, sec. 225(k)(6). Moreover, even if petitioner had reported its adjusted ordinary gross income in the same inconspicuous manner in which it included the other information pertaining to its gross income, petitioner could not be regarded as having complied with section 6501(f). Although the Supreme Court in Commissioner v. Lane-Wells Co., 321 U.S. 219">321 U.S. 219, was dealing with a requirement then in effect regarding the filing of a separate return for personal holding companies on Form 1120H notwithstanding that all pertinent information may have been reported in the1975 U.S. Tax Ct. LEXIS 120">*160 regular corporate return on Form 1120, its reasoning is equally applicable here in respect of the present requirement that a separate schedule (specifically 64 T.C. 510">*527 identified in the Forms 1120 in use in the taxable years as Schedule 1120PH) be filed along with Form 1120. The Court made clear that the purpose of requiring that the pertinent information be set forth separately (321 U.S. 219">321 U.S. at 223):

is not alone to get tax information in some form but also to get it with such uniformity, completeness, and arrangement that the physical task of handling and verifying returns may be readily accomplished. * * *

Not only did petitioner fail to include this information in a readily usable fashion, it effectively disguised what information was reported by failing to check the box provided on its Forms 1120 identifying itself as a personal holding company. Cf. Mayfair Minerals, Inc., 56 T.C. 82">56 T.C. 82, 56 T.C. 82">92, affirmed 456 F.2d 622 (5th Cir.).

1975 U.S. Tax Ct. LEXIS 120">*161 Statutes which bar the collection of taxes otherwise due and unpaid are matters of congressional consent and are to be strictly construed in favor of the Government. Lucia v. United States, 474 F.2d 565, 570 (5th Cir.); McDonald v. United States, 315 F.2d 796, 801 (6th Cir.); Pacific Coast Steel Co. v. McLaughlin, 61 F.2d 73, 75 (9th Cir.); Loewer Realty Co. v. Anderson, 31 F.2d 268, 269 (2d Cir.). Petitioner has clearly failed to comply with the explicit return requirement of section 6501(f) for which reason the applicable period of limitations is 6 years. The deficiency notice herein was therefore timely mailed. West Coast Ice Co., 49 T.C. 345">49 T.C. 345, 49 T.C. 345">350. On account of the applicability of section 6501(f), we do not reach the question raised by petitioner as to the breadth of the consent obtained by the Commissioner by reason of an executed Form 872 which covered "any Federal income and profits taxes due" under any return made by the taxpayer.

2. Second examination. -- The second of petitioner's procedural objections concerns1975 U.S. Tax Ct. LEXIS 120">*162 the alleged second audit of its returns for the taxable years ended October 31, 1967 and 1968, both of which were stamped "Closed on Survey," on account of which petitioner argues the deficiencies determined in respect of those years are void. Petitioner's authority for such a conclusion is unclear. Section 7605(b)¹² and the accompanying regulations (section 64 T.C. 510">*528 301.7605-1) upon which it relies, are inapposite inasmuch as the parties have stipulated that the Commissioner conducted only one actual inspection of petitioner's books, and it is well settled that that section has no bearing upon the Commissioner's authority to examine tax returns already in his possession. Cf. United States v. Dawson, 400 F.2d 194, 200 (2d Cir.); Geurkink v. United States, 354 F.2d 629, 631 (7th Cir.); DeMasters v. Arend, 313 F.2d 79, 85-86 (9th Cir.); Robert F. Collins, 61 T.C. 693">61 T.C. 693.

1975 U.S. Tax Ct. LEXIS 120">*163 Likewise, petitioner's reliance upon section 601.105(j), Proced. & Admin. Regs., ¹³1975 U.S. Tax Ct. LEXIS 120">*165 is misplaced. Those regulations are intended to govern the reopening of cases which are closed after examination. The two returns in controversy at this point were not previously "examined" at all. They were merely checked for form, execution, mathematical accuracy, and were "surveyed" for classification. As a result of that "survey" it was determined that they would not be "examined" -- i.e., that there would not be either a field audit or an office audit -- and the words "Closed on Survey" were then stamped on the face of the returns to reflect such classification. See secs. 601.103(b) and 601.105(a), Proced. & Admin. Regs. ¹⁴1975 U.S. Tax Ct. LEXIS 120">*166 That "survey" or "classification" was not an 64 T.C. 510">*529 "examination" within the meaning of section 601.105(j), and that this is the proper meaning to be given the word "examination" as thus used is made clear by the context in which the matter is treated in Rev. Proc. 72-40, 1972-2 C.B. 819-820, which is concerned with "agreed" and "unagreed" cases, situations that obviously contemplate the conduct of audits and conferences1975 U.S. Tax Ct. LEXIS 120">*164 with the taxpayer or his representatives. There has thus been no closing of the cases after "examination" within the meaning of the regulations, ¹⁵ and therefore the reopening procedure provided for in section 601.105(j) is inapplicable. Moreover, and finally, these procedural rules are merely directory, and like other similar procedural rules "compliance with them is not essential to the validity of a notice of deficiency." Luhring v. Glotzbach, 304 F.2d 560, 563 (4th Cir.). Accord, Cleveland Trust Co. v. United States, 421 F.2d 475, 481-482 (6th Cir.); Geurkink v. United States, 354 F.2d 629, 632 (7th Cir.); Robert F. Collins, 61 T.C. 693">61 T.C. 693, 61 T.C. 693">701; Anthony B. Cataldo, 60 T.C. 522">60 T.C. 522, 60 T.C. 522">523; Philip F. Flynn, 40 T.C. 770">40 T.C. 770, 40 T.C. 770">773.

Decision will be entered for the respondent.