Henderson Clay Products v. United States

377 F.2d 349, 19 A.F.T.R.2d (RIA) 1140, 1967 U.S. App. LEXIS 6780

• Court: Court of Appeals for the Fifth Circuit
• Decided: April 11, 1967
• Docket: 23771_1
• Status: Published

Opinions

TUTTLE, Chief Judge:

This is the second appeal to this court which raises the problem of ascertaining the proper base on which to determine the depletion allowance for an integrated miner-manufacturer of bricks processed from ball clay and from ordinary brick and tile clay.

The rates of depletion allowed by statute differ with respect to ball clay and brick and tile clay. The rate is 15% for the ball clay, whereas it is only 5% for brick and tile clay.

The legal issues respecting the two different types of clay differ also in the fact that it is undisputed in the record before us, and it has been earlier decided by us in United States of America v. Henderson Clay Products Company, 5 Cir., 324 F.2d 7, that there is a commercially marketable product, known as “shredded ball clay,” in which market the taxpayer could have disposed of his mined ball clay, thus giving rise to the application of the statutory provision that the base for depletion is a figure that would represent either the “representative market or field price” of shredded ball clay, or, if none could be established, then the figure would be arrived at by taking the “representative market or field price” of the finished brick, minus the cost and proportionate profits attributable to the processes beyond those necessary to produce the shredded ball clay. The applicable statutes are found under the Internal Revenue Code of 1954.¹

The question relating to the figuring of depletion with respect to the ordinary brick and tile clay is of a different kind. It is undisputed in this record that there is no marketable product following the extraction of the clay from the ground until the final completion of the manufacture of the clay into bricks. Until the passage of a new statute by the Congress of the United States in 1961, brick manufacturers dealing with ordinary brick clay were permitted to base their depletion on the gross income upon the sale of the finished product. See United States v. Cherokee Brick and Tile Co., 5 Cir., 1955, 218 F.2d 424, United States v. Merry Brothers Brick and Tile Company, 5 Cir. 1957, 247 F.2d 708, cert. denied 1957, 355 U.S. 824, 78 S.Ct. 31, 2 L.Ed.2d 38.

On September 26, 1961, Congress passed a statute which offered to brick and tile manufacturers an option to compute their taxes in a different manner. The taxpayer contends that it exercised the option with respect to the tax year in question. The government contends to the contrary. This is the only issue respecting the right of recovery by the taxpayer of the amount paid on the deficiency notice resulting from the depletion allowance on the brick and tile clay.

The tax year in question before the court here is the fiscal year ended March 31, 1955. This court had before it, on an earlier appeal, a similar question with respect to the proper basis for computing the depletion on the ball clqy for the fiscal years 1951, 1952, 1953 and 1954. In that case the record disclosed that the appellant used ball clay, as it still does, solely for the purpose of manufacturing bricks; that nevertheless during the life history of the clay products from the time the clay was taken from the ground until it was ready for the builder, it passed through a stage known as “shredded ball clay”; that there were clay miners, principally in a Kentucky and Tennessee mining area, who mined and sold shredded ball clay all 'over the United States, including the area in which Henderson had its clay mines; that the market price for such clay was $10.50 per ton; that, although Henderson sold its finished brick at $8.75 per ton, it claimed that under the teaching of United States v. Cannelton Sewer Pipe Company, 1963, 364 U.S. 76, 80 S.Ct. 1581, 4 L.Ed.2d 1581, it was entitled to take depletion on the $10.50 figure, or $1.75 per ton more than it received for finished brick.

This court determined that a price of $10.50 per ton for the admittedly marketable product, shredded ball clay, was not a “representative field price,” as to a manufacturer of bricks who used a like grade and quality of clay for the manufacture of bricks which it sold for $8.75 per ton.

This second case comes to us following the filing of a refund suit by Henderson seeking a refund of the taxes paid for fiscal 1955 as distinguished from the prior cases which covered the years through fiscal 1954. The complaint in this case also alleged that there was a market for shredded ball clay at $10.50 a ton, as had the earlier complaints. Nevertheless, the case coming to trial after the court decided the earlier case, the parties stipulated that the market price that was being obtained for shredded ball clay was $10.00 per ton, as contrasted with the $10.50 that had been proved as to the earlier years. The stipulation also established the fact that during fiscal 1955, Henderson sold its finished brick for $12.38 per ton, as contrasted to $8.75 per ton during the prior four years. Thus, Henderson sought to distinguish the facts of this case from the earlier case by reason of the fact that the final product, the finished brick, was sold by Henderson for $2.38 more per ton than the available market price for shredded ball clay.

However, while most of the facts were stipulated in the trial court, there were two circumstances testified to which have a significant bearing on the finding of the trial court that the 1955 case did not so far differ from the earlier cases as to warrant a finding by the trial court that depletion could be computed by Henderson on the $10.00 market price for shredded ball clay. These two circumstances are: (1) testimony by the president of the taxpayer that if Henderson had bought shredded ball clay at $10.00 per ton, delivered at its pug mill in Texas, instead of mining its own clay, it would just about have “broken even” on its operation.² (2) The record discloses that the sales by the Kentucky-Tennessee clay miners were of shredded' ball clay and a further processed product, air-floated clay, and in his testimony, following evidence that Henderson could have sold shredded ball clay at $10.00, Mr. Bryce stated that he could not have' competed with the Kentucky-Tennessee' miners unless he had gone into the processing of shredded ball clay into air-floated clay, and that this would have taken additional equipment which his company did not have.³

The problem for the court here, as in the last case, was, first, to determine whether a marketable product resulted at a stage following the removal of the clay from the pits and before the final finishing of the bricks, and, second, if it was determined that there was such a marketable product, to ascertain whether there was a “representative field price” that prevailed for such market, and, if there was no such representative field price, then to determine the gross income from mining by the proportionate profits method, as provided in the regulations.⁴

The Cannelton decision determined that the question whether a marketable product existed must be viewed industry-wide rather than from the viewpoint of the particular miner-manufacturer. The fact that a manufacturer of bricks or a clay pipe manufacturer did not himself sell the raw clay or the limestone or other unfinished products, did not preclude a finding that there existed a marketable product short of the final manufacturing process. It is clear here, as we held in our earlier decision, that in ball clay mining there is a commercially marketable product in the nature of shredded ball clay produced before the final manufacturing into brick commences. The first part of the problem is thus answered in the affirmative — that is, there is a commercially marketable mineral product which Henderson later processes additionally to produce its brick. We thus apply clause 3 of the Regulations to ascertain whether the term “gross income from the property” is to be found by using a representative market or field price or by using a proportion of profits computation. The Cannelton case does not aid us in this regard.

As we stated earlier, “We observe that in Cannelton the question was one of identifying the first commercially marketable product so as to mark the end of the mining process for the purposes of Section 114(b) (4). The court held that commercial profitability was not relevant in defining the product which had passed sufficiently from its natural state so as to become marketable. The case was remanded to be treated according to Regulation 39.23(m)-l(e) (3); there is no indication that the proceedings in the Supreme Court have any bearing on this determination over and above the establishment of the ‘product’ on which the depreciation allowance is to be granted.” (Emphasis added) 324 F.2d 7,15.

We also said in our earlier case:

“The competitive market approach is to be used only if there is a ‘representative market or field price’ of an essentially similar product. The Regulation does not allow the indiscriminate use of any price of a product of like kind and grade, but requires the price to be representative; ‘representative’ should be interpreted to qualify the entire phrase ‘market or field price’ ”.

We conclude that on any one of three different approaches we must affirm the determination by the trial court that the $10.00 price received by the shredded ball clay miners was not, as to Henderson, a representative market or field price.

The first approach is that suggested in the prior decision, where this court pointed out that substantial items of expenditure were made by the shredded ball clay miners by way of research, advertising and marketing, all of which became ingredients in the sales price of $10.00 per ton, whereas, Henderson did not engage in these expenditures as directed to the creation of, or filling, the market for shredded ball clay. Thus, the $10.00 price was more than “the representative market or field price (as of the date of sale) of a mineral product of like kind or grade as beneficiated by the ordinary treatment processes actually applied,” because it represented a price that was substantially enhanced by expenditures other than for the “ordinary treatment processes actually applied.” While it is true that the Kentucky-Tennessee ball clay miners could take the gross sales price, including costs of promoting and selling, as the gross income from the property, we pointed out in our earlier decision that these expenses which were not incurred by this taxpayer kept the $10.00 price from being representative as to it.

The second approach relates to the fact that Henderson, according to the testimony of its president, was not actually making one of the two products which it had to be prepared to market together in order to compete in the shredded ball clay market. Thus, the price of $10.00 achieved by the Kentucky-Tennessee miners was a price which resulted from their position that enabled them to supply not only shredded ball clay, but also air-floated clay. Without being able to supply the latter product, Mr. Bryce testified that his company could not have ■ competed in the sales of shredded ball clay, presumably because the purchasers of one required the other as well. There is, therefore, no basis for the finding by the trial court that the market price in Texas for shredded ball clay was the same $10.00 realized in Kentucky and Tennessee.⁵

Finally, just as in our earlier opinion we found it incomprehensible that Henderson would buy shredded ball clay at $10.50 per ton to produce brick which it then sold at $8.75 a ton, so we determine that under the undisputed facts of this record, it is equally incomprehensible that Henderson would pay $10.00 for shredded ball clay at the mines in Kentucky and Tennessee, transport it to east Texas, and then process it into finished brick, where the testimony showed that if they were able to have the brick at $10.00 laid down at their own pug mill, they would just about break even.

Not only is it evident that the $10.00 price would not be a “competitive” price, so far as Henderson was concerned if it had sought to compete with the Kentucky-Tennessee miners in selling shredded ball clay, it is also evident that it would be a price which, when added to the cost of processing the brick, would produce a final figure in excess of the $12.38 average sales price, for the finished brick for the year in question. In this connection, it is more than significant that Henderson, in a reply brief, specifically calls our attention to a proposed regulation dealing with this precise subject. This is quoted as paragraph 4 of Proposed Regulations, published 31 Fed. Regulations 9506 (July 13, 1966) dealing with “percentage depletion; rates; gross income from the property.” Appellant characterizes these proposed regulations as “interesting as showing the meaning of ‘gross income of the property.’ ” Then, following liberal quotations from the regulations, appellant says “These regulations present in clear and unmistakable language the views which appellant has sought to express in this case.”

A quick glance at these proposed regulations indicates, however, that the quotations from the regulations stop short of that particular section which most clearly fits the circumstances of the appellant in this case. The following language was not included in the part of the regulations quoted in the appellant’s brief:

“(6) Limitation on gross income from mining computed under the provisions of this paragraph. No price shall be considered a representative market or field price for the taxpayer’s ore or mineral if the sum of such price plus the costs of the nonmining processes which the taxpayer applies to his ore or mineral exceed the taxpayer’s actual sales price of the product sold.”

These proposed regulations are, of course, not binding until adopted by the Commissioner of Internal Revenue. Nevertheless, as indicated by appellant itself, they are strongly persuasive of the commissioner’s view of the proper construction of the statute. Here appellant claims to concur with the commissioner’s “view”. If we were to accept appellant’s flat statement that these proposed regulations “present in clear and unmistakable language the views which appellant has sought to express in this case,” and include the language which is quoted above, as well as that which appellant included in its brief, then it is clear beyond a doubt from this record that the new regulations would preclude the inclusion of the $10.00 price of the Kentucky-Tennessee miners here as a representative market or field price within the contemplation of the statute. Without question this sum of the $10.00 price, plus transportation, plus “the costs of the nonmining processes which the taxpayer applies to his minerals” exceeded the “actual sales price of the product sold.” In any event, this is the commonsense construction of the statute, which, whether it be finally adopted as a regulation or not, represents this court’s view of the matter when dealing with hypothetical income of the taxpayer for the sale of products which it does not sell, and which includes items of expenditure which this taxpayer does not incur.

We turn finally to the attempted recovery of the payment made on account of the deficiency assessed against taxpayer because of its treatment of depletion on its ordinary brick and tile clay. With regard to this product, the Act of September 26, 1961,⁶ provided for an election under subsection (c) for the purpose of applying section 613(c) of the Internal Revenue Code of 1954. The statute expressly provided that such election was to be made in such form and manner as the Secretary of the Treasury or his delegate should prescribe by regulations. The regulations, duly prescribed under this section, provided that an election must be made on or before December 11, 1961, for prior years. As an integral part of the election, section 1.9004-4 also required the filing of amended returns for the years to which the election was or could be applicable. The regulations required the filing of amended returns on or before March 31, 1962. It is not in dispute that the taxpayer knew of the requirement as to the filing of amended returns and of the cut-off date.

In effect, appellant argues that it made the election for the year 1961, and claims this was an effective compliance with the statute. It argues that the general language of the statute did not authorize the specific requirement of the regulations that it make its completed election for each year and that it file an amended return for each year. We think it too plain to require elaboration that the provisions in the regulations requiring the filing of an amended return for each of the years for which the election was sought to be applied was a valid regulation issued under the mandate of the statute and that the failure to file such amended return for the year in issue precludes the right of recovery, as determined by the trial court.

The judgment is affirmed.

1 . “§ 611(a), General Rule — In the case of mines * * * there shall be allowed as a deduction in computing taxable income a reasonable allowance for depletion and for depreciation of improvements, according to the peculiar conditions in each case; such reasonable allowance in all cases to be made under regulations prescribed by the Secretary or his delegate * * * ” 26 U.S.O.A. § 611.

“§ 613, Percentage Depletion, (a) General Rule — In the case of mines, * * * (b) The allowance for depletion under section 611 shall be the percentage, specified in subsection (b) [15% here] of the gross income from the property, excluding from such gross income an amount equal to any rents or royalties paid or incurred by the taxpayer in respect of the property. Such allowance shall not exceed 50% of the taxpayer’s taxable income from the property (computed without allowance for depletion) * * * ”

“(G) Definition of gross income from property — For purposes of this section— (1), Gross income from the property— The term ‘gross income from the property’ means, in the case of a property other than an oil or gas well, the gross income from mining.

“(2) Mining — The term ‘mining’ includes not merely the extraction of minerals from the ground but also the ordinary treatment processes normally applied by mine owners or operators in order to obtain the commercially marketable mineral product or products, and so much of the transportation of ores or minerals (whether or not by common carrier) from the point of extraction from the ground to the plants or mills in which the ordinary treatment processes are applied thereto as is not in excess of fifty miles * *

2 . The question was asked of Mr. Bryce, the President: “How would Henderson Olay Products have come out if in 1955 it had purchased shredded ball clay, laid down at its pug mill, at $10.00 a ton, and made such clay into brick and sold it at $12.38 per ton, which it is stipulated is the average ton sales price of your brick?” Answer: “Well I asked that question to my accountant recently, and he said in the year 1955 that it would have been about a break even proposition.” (Emphasis added.)

3 . “In selling the clay in the shredded stage, I use the same equipment — the shredders —that the ball clay people use; but had I been in the ball clay business, then I couldn’t have gotten along by just selling shredded clay- — I would have had to have had — would have to have pulverized it or air-floated it — the clay — which would have taken this other equipment that you mentioned, you see.” Question: “And you did not have that — You did not put that extra equipment in in 1955, did you?” Answer: “I had no need for it. I wasn’t .using the * * *. I had sjt * * ti

4 . “The applicable Treasury Regulations are as follows: “Section 29.23(m)-l. Depletion of Mines * * * (e) As used in Sections 114(b) (3) and 114(b) (4) (A), and Sections 39.23(m)-l, to 39.23 (m) -19, inclusive, the term, ‘gross income from the property’ means the following:

“(2) In the case of a crude mineral product other than oil and gas, ‘gross income from the property,’ as used in section 114(b) (4) (A), means the gross income from mining. The term ‘mining’ as used herein includes not only the extraction of ores or minerals from the ground but also the ordinary treatment processes which are normally applied by the mine owners or operators to the crude mineral product after extraction in order to obtain the commercially marketable mineral product or products. * * *

“(3) If the taxpayer sells the crude mineral product of the property in the immediate vicinity of the mine, ‘gross income from tile property’ means the amount for which such product was sold, but, if the product is transported or processed (other than by the ordinary treatment processes described below) before sale, ‘gross income from the property’ means the representative market or field price (as of the date of sale) of a mineral product of like kind and grade as beneficiated by the ordinary treatment processes actually applied, before transportation of such product (other than transportation treated, for the taxable year, as mining). If there is no such representative market or field price (as of the date of sale), then there shall be used in lieu thereof the representative market or field price of the first marketable product resulting from any process or processes (or, if the product in its crude mineral state is merely transported, the price for which sold) minus the costs and proportionate profits attributable to the transportation (other than transportation treated, for the taxable year, as mining) and the processes beyond the ordinary treatment processes. * * * ”

5 . Although one witness did testify that Henderson could sell shredded ball clay in east Texas itself at $10.00 a ton, this testimony must be taken together with that of the president of the company who said that in order for it to have engaged in this market it would have had to add equipment to permit it to sell air-floated clay, which it did not have.

6 . P.1,. 87-312, 75 Stat. 674.