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Abstract
This article will examine the federal income tax issues associated with issuing, holding and hedging of a volumetric production payment (VPP). A VPP gives the holder the right to receive a series of in-kind payments of a specified volume of mineral production and, if certain other requirements are met, is treated as a mortgage loan under Code Sec. 636(a). As will be seen, the peculiar features of a VPP -- a financial instrument treated as debt by statute but which has no fixed payments -- create some challenging issues in determining how the tax rules for accruing original issue discount on debt instruments should apply. The article also discusses several examples comparing the holder's economic results, in both hedged and unhedged scenarios, in a market environment when the price of the mineral undergoes an unexpected and significant decline during the term of the VPP.