Rev. Rul. 67-118

Advice has been requested whether the income of a trust, under the circumstances described below, is taxable to the grantor.

The taxpayer is the owner of certain producing oil and gas leases, out of which he created and transferred in trust certain overriding royalty interests. The trust was established by the grantor for the benefit of a college and is for a term of five years. The entire net income of the trust is irrevocably payable to the college during the term of the trust. Under the provisions of the trust, the trustees may deal with the overriding royalties as if they were the absolute owners thereof. Upon termination of the trust, the overriding royalties, which have an economic life exceeding the term of the trust, or the proceeds of any sale of such royalties, will revert to the grantor.

When income-producing property is placed in trust, the tax liability generally shifts from the grantor in accordance with part I, subparts A through D of subchapter J of the Internal Revenue Code of 1954, sections 641 through 668, inclusive. However, the grantor will remain taxable on the trust income if he retains such dominion and control over the trust corpus as to be considered the substantial owner of the corpus under subpart E of subchapter J, sections 671 through 677.

Section 673(a) of the Code provides in effect that the grantor shall be treated as the owner of any portion of a trust in which he has a reversionary interest in either the corpus or the income therefrom which will or may reasonably be expected to take effect within ten years from the date of transfer to the trust. Subsection (b) of section 673 of the Code provides that subsection (a) shall not apply to the extent that the income of a portion of a trust in which the grantor has a reversionary interest is, under the terms of the trust, irrevocably payable for a period of at least two years to a designated beneficiary of a type described in section 170(b)(1)(A)(i), (ii), or (iii) of the Code. However, if the grantor merely assigns the right to future income to the trust, he will be taxed on the income even though he retains none of the controls specified in sections 671 through 677 of the Code. See section 1.671-1(c) of the Income Tax regulations; H. Rep. No. 1337, 83d Cong., 2d Sess., A212; and S. Rep. No. 1662, 83d Cong., 2d Sess., 365 (1954).

An overriding royalty interest may be defined as an economic interest in oil and gas in place, created from the working interest, which entitles its owner to a specified fraction of gross production, free of operating and development costs. The term of an overriding royalty interest is coextensive with the term of the working interest from which it was created. The transfer of an overriding royalty is an assignment of a property interest and is not an anticipatory assignment of income. This is in contrast to the transfer of an in-oil payment right carved out of a larger interest, which is such an assignment of income. See G.C.M. 24849, C.B. 1946-1, 66.

Accordingly, a transfer in trust of an overriding royalty created from a leasehold which is retained by the grantor is not a mere assignment of future income so as to cause the grantor to remain taxable in accordance with the provisions of section 1.671-1(c) of the regulations. Since the college in this case is a beneficiary which `is of a type described in section 170(b)(1)(A)(i), (ii), or (iii)' of the Code and the entire net income of the trust is irrevocably payable to such beneficiary for a period in excess of two years, the income attributable to the overriding royalties will not be taxed to the grantor provided he is not considered the owner of the trust under one of the other provisions of subpart E of subchapter J of the Code.