Commissioner of Internal Revenue v. Portland Cement Company of Utah – Oral Argument – January 13, 1981

Media for Commissioner of Internal Revenue v. Portland Cement Company of Utah

Audio Transcription for Opinion Announcement – March 03, 1981 in Commissioner of Internal Revenue v. Portland Cement Company of Utah

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Warren E. Burger:

Thank you, gentlemen.

The case is submitted.

We’ll hear arguments next in Commissioner of Internal Revenue against Portland Cement Company.

I think you may proceed when you’re ready, Mr. Smith.

Stuart A. Smith:

Thank you.

Mr. Chief Justice, may it please the Court.

This income tax case here — comes here on a writ of certiorari from the United States Court of Appeals for the Tenth Circuit.

The questions involve an application of a well-established formula method set out in the regulations for more than 40 years for measuring the gross income from mining of a taxpayer who mines and, thereafter, produces a finished manufactured product, the so-called integrated miner-manufacturer.

The object of the formula which we also call the proportionate profits method is to determine the price at which the taxpayer would have sold his mine or to itself in a hypothetical sale, so as to confine the depletion deduction to its intended purpose of compensating for the exhaustion of the mineral deposit.

The depletion deduction is a fixed percentage of gross income from mining.

The method, the proportionate profits method, is employed as it was in this case where there is no representative field price or sales of actual sales at the cut-off point at — at the point in which the mining activity ceases or whether it’s essentially at arm’s length.

And the underlying theory of the proportionate profits method, which is a cost ratio method which is set out in our brief at pages — at page 3, it’s a formula which essentially multiplies a fraction, the numerator of which is mining costs over total costs, that is, mining plus non-mining costs times the gross sales of the first marketable product which here is finished Portland Cement and that figure —

Byron R. White:

May I ask you right there, that gross sales figure?

That is the actual — that isn’t the constructed figure, is it?

Stuart A. Smith:

No, no.

Byron R. White:

That is an actual figure representing the sales price of the finished product whatever that product is.

Stuart A. Smith:

Exactly, exactly.

Byron R. White:

Of the first marketable product.

Stuart A. Smith:

Of the first marketable product.

Byron R. White:

And so that if it normally, that — that price would be enough to cover all costs, anyway —

Stuart A. Smith:

Yes.

Byron R. White:

— or they’ll go broke.

Stuart A. Smith:

Exactly.

Byron R. White:

So, it’s — it’s — so it’s the gross sales price.

Stuart A. Smith:

Exactly.

And the theory of the — the underlying theory of the method is that each dollar of costs earns its proportionate share of gross sales and thereby of profits.

And the questions in this case are two and they involve a — they may involve — both involve detailed applications of the method.

The first question involves — is — is whether the gross sales figure, that is, the multiplier of the first marketable product includes bulk and bagged cement as the regulations require or whether as respondent contends simply bulk cement.

And the second question involves the denominator of the fraction, that is, the total cost and whether the — whether those — whether that denominator should include costs of bags, bagging, storage, distribution and sales should be included as the regulations require.

Potter Stewart:

Now, the two questions are separate.

Potter Stewart:

They’re — they’re interrelated, are they not?

Stuart A. Smith:

Absolutely, absolutely.

Potter Stewart:

I mean, they have to kind of be answered the same way —

Stuart A. Smith:

Exactly.

Potter Stewart:

— consistently.

Stuart A. Smith:

Exactly.

Byron R. White:

So you could include the first question and still not —

Potter Stewart:

No.

Byron R. White:

— change the — the denominator, could you?

Potter Stewart:

No.

Stuart A. Smith:

Well, the questions are interrelated.

I think the — the —

John Paul Stevens:

Well, so — but your — but if — if your first marketable product is bulk cement —

Potter Stewart:

Right.

John Paul Stevens:

You’re certainly not going to include in the denominator the cost of bagging.

Potter Stewart:

No, exactly.

No.

Stuart A. Smith:

The facts —

Potter Stewart:

(Inaudible)

Stuart A. Smith:

Sure.

Potter Stewart:

On the tax — this tax return, did the taxpayer — or with respect to gross sales cost, on — an office administrative cost, did the taxpayer seek to exclude them entirely or to place some of them in the numerator?

Stuart A. Smith:

My — my understanding is that he sought to exclude them entirely.

That — that’s basically the position — that’s basically the position of the court below which is we set forth in our petition in our brief is really — has been out of line with not only the regulations but with all the other Courts of Appeals.

Potter Stewart:

Does the tax take — take a different position on that that it did in the court below?

Stuart A. Smith:

I think so.

My understanding in looking at the briefs now is the taxpayer is — is seeking a prorated — prorated approach.

Harry A. Blackmun:

Well, Mr. — Mr. Smith, if the court below it agreed with you that the first marketable product was both bulk and bagged cement, I’m not sure it would have excluded any cost from the denominator.

Stuart A. Smith:

Well, it’s hard to tell.

I mean, I can’t —

Harry A. Blackmun:

Well, I know, but it — it said that the first marketable product was bulk cement.

Stuart A. Smith:

Yes, yes, so, it more or less then —

Harry A. Blackmun:

In this event, you should throw out some costs from the denominator.

Stuart A. Smith:

Yes, and I — they said —

Harry A. Blackmun:

So, your first question, if you went on the first question, you —

William J. Brennan, Jr.:

— you win.

Stuart A. Smith:

I think I really win on the first question as a logical matter, the second question is a subsidiary question which takes care of itself but it’s —

Byron R. White:

Exactly — exactly —

Stuart A. Smith:

— it’s hard — it’s hard to know exactly how the court below felt about this question generally because it had — this question has been kicking around in the Tenth Circuit ever since the — it’s the idea of basic test.

Harry A. Blackmun:

Yes, but there’s no suggestion that they would throw those costs out of the denominator even if —

Stuart A. Smith:

No.

Harry A. Blackmun:

— even if the first marketable product —

Stuart A. Smith:

No.

Harry A. Blackmun:

— was bagged cement.

Stuart A. Smith:

What the — what the Tenth Circuit has said and which we take strong disagreement with is that the first marketable product was bulk cement.

Let me just simply sketch out the facts which are relatively simple.

Warren E. Burger:

Which do they sell most of by the way?

Stuart A. Smith:

They sell mostly bulk cement.

The bagged cement, accounts for about 7% or 8% of its — 7 or 8, so let me put it this way.

The cement in bags, it’s the same product.

It’s whether it’s sold in a railroad car, whether it’s packed in bags pursuant to particular kind of customer demand, the cement in bags.

The facts are relatively simple.

This respondent, like all others, in the cement industry is an integrated mine — miner-manufacturer of Portland Cement.

The mining process involves a quarrying and a digging of this cement rock.

It’s a calcium carbonate kind of rock.

It’s reduced in size.

It’s then ground to a high degree of fineness.

Water is added to produce something called the “slurry” and then that slurry is stored in tanks and agitated to maintain uniform mixture until — until such time as it passes through the manufacturing process.

John Paul Stevens:

Mr. Smith —

Stuart A. Smith:

What —

John Paul Stevens:

— is it agreed that the — the mining phase stops at the point where slurry is —

Stuart A. Smith:

Yes, I think that is — that is agreed because the mining process, and Congress has you know ratified this in Section 613 (c) (4) (F) which was enacted in response to the Court’s Cannelton decision, the mining process stops at the kiln feed.

Everything after that is non-mining and then this liquid slurry, as I have adverted, is then fed into these rotary kilns and that — which are fired and a hard substance called a “clinker” is ultimately formed.

That clinker is cooled, ground up with purchased gypsum to produce the finished cement and then there’s a final grinding and then the finished cement is stored in silos.

Some of the cement is sold in bulk, in tank cars or piggyback or gondola cars, a variety of different forms for large consumers that need — that need cement in that kind of quantity.But the important thing is that cement has to be kept dry, otherwise, it becomes wet, it becomes worthless.

So some people don’t need that much cement and if — and for those customers, this manufacturer, as well as all to others in the integrated industry, pack the bag — pack the cement in bags of these — which are a standard 94-pound weight, as I understand.

John Paul Stevens:

Mr. Smith, I suppose it never happens, but suppose this manufacturer sold everything in — in bags, would you have a different case?

Isn’t (Voice Overlap) —

Stuart A. Smith:

Then I — I — we’d have a different case but I don’t think there would be a quarrel.

I mean, essentially, it would be the same marketable product, in our view, would still be cement, the bagging cost would be a cost of sale and we would contend that that would be — that that would have to go into the denominator and the bagging —

Warren E. Burger:

So, the (Voice Overlap) —

Stuart A. Smith:

— premium would go —

Warren E. Burger:

— would take the same position that he does here?

Stuart A. Smith:

Right, but I assume that this taxpayer couldn’t really argue that anything else was a first marketable product.

Thurgood Marshall:

Mr. Smith, it — it has nothing to do with this case at all.

But what’s the difference between concrete and cement?

Stuart A. Smith:

Concrete, as I understand it, and I should know this, because I’m a city boy, I think is — it — is what happens when the cement is put in the building and hardens.

I think you talk about a concrete sidewalk.

I don’t think you talk about a cement sidewalk, but I could be wrong on that.

Well, the — this taxpayer, the respondent computed its gross income from mining in accordance with the proportionate profits method.

Indeed, it had to because, as I said, there is no representative field price and it did not sell, and as nor did anyone in this industry sell kiln feed, so there’s no way to know how much kiln feed would sell for.

But contrary to the command of the regulations and I have to emphasize that these regulations which are set forth in detail and are at the appendix to our brief are detailed and more or less preempt this area and preempt it in accordance with a command of Congress in section 611(a) that the commission to promulgate such regulations, the respondent computed its gross income by excluding bagged cement from the computation and by excluding the cost of bagging, storage, distribution and sales from the total costs element in the form and of the so-called “the — the denominator in that fraction.”

The Tax Court in this case upheld the respondent because the Tax Court has a rule in which it will follow the relevant circuit to which a case will go, the so-called “Golsen rule” and since the Court of — this Court of Appeals had already expressed itself in the idea of basic case, that’s why the Tax Court held the way it did and the Court of Appeals followed its idea of basic decision.

Now, in our view with respect to the first question, the respondent’s first marketable product is finished cement, regardless of the form of packaging.

As I said, the theory of the proportionate profits method is that each dollar of costs produces the same percentage of profits to exclude any costs or any element of any aspect of gross sales received in production or a sale of the first marketable product ompromises the integrity of the formula.

Byron R. White:

Well, what about companies that sell on delivered price basis and they pay for transportation?

You don’t include transportation.

You — you deduct transportation costs from gross sales price, don’t you?

Stuart A. Smith:

Only certain kinds of transportation, Mr. Justice White.

Byron R. White:

The ones you don’t make a profit on?

Stuart A. Smith:

Well, essentially, if — if they’re delivered over, they would transport it and it’s the transport as profit.

Stuart A. Smith:

That is — that is an accommodation that the regulations make with respect to purchase —

Byron R. White:

So, you do not — so you did not include all elements of gross sales?

Stuart A. Smith:

Well that — that as I understand is the only element of gross sales that is not included.

Byron R. White:

Why — why isn’t it included?

Stuart A. Smith:

It’s not included as I —

Byron R. White:

Because the company doesn’t make a profit on it.

Stuart A. Smith:

Because the company — basically, because it’s to transport is profit —

Byron R. White:

Well —

Stuart A. Smith:

— but —

Byron R. White:

So — so yes, I’m right that the company itself doesn’t make a profit on it.

Stuart A. Smith:

The company does not make a profit on the transportation but —

Byron R. White:

But what if they didn’t make any profit on its bagging?

Stuart A. Smith:

If — well, I don’t think we have to worry about that in this case because —

Byron R. White:

I know you don’t want to worry about it but that’s the very worry in the case.

Stuart A. Smith:

No, it’s not the very worry in the —

Byron R. White:

But that’s one of them.

Stuart A. Smith:

Well, no, it isn’t, Mr. Justice White.

And the reason it isn’t is because the — the respondent — because it’s been stipulated in this case that the respondent realized the net profit on the sale of each bag of cement and it —

Byron R. White:

That is not — that it is not stipulated that he made a profit on his bagging expense on the bag.

Stuart A. Smith:

Well, if you — yes.

Byron R. White:

Is it?

Stuart A. Smith:

Yes, it is not stipulated that he made a profits on —

Byron R. White:

As a matter of fact, the claim is that he loses, that it cost him more to bag than he — than he adds to the price from the bagging.

Stuart A. Smith:

Yes, but the — but the point of the proportionate profits method is that it has to measure the sales of the — of a finished product and part of the — and the — with this respondent as well as all other cement-integrated producers sold bagged cement in response to a customer demand, put cement in bags and there is no suggestion here that — and it seems to me that the relevant fact is that this respondent earned a profit on each bag of cement that it sold.

And once it is assumed that that is a profitable aspect of its business, all of that has to go into the equation.

Byron R. White:

Except — except the transportation because he doesn’t make a profit on them.

Stuart A. Smith:

Well, except transportation because transportation basically is taken out of his hands and put into the hands of the transporter.

And the point — our point is with respect to transportation that I know that the —

Byron R. White:

But the point is that he doesn’t make a profit out of it.

Stuart A. Smith:

Exactly, exactly, but — but he — but he did make a profit on the sale of bagged cement and I think that makes all the difference in the world.

Byron R. White:

I know you do.

Stuart A. Smith:

The conditions of the regulation, the purchase — transportation regulations are set forth at page 13(a) of our — of our appendix to our brief and you can see that the conditions are very narrow.

It says which are — it’s not transportation conducted by the taxpayer but which is performed in conveyances owned or leased by persons other than the taxpayer rather than in conveyances owned or leased by the taxpayer which are performed solely to deliver the taxpayer’s minerals and mineral products to the customer rather than to transport such minerals or products for packaging or other additional processing which you charge the customers in such a way that the taxpayer does not ordinarily earn any profit with respect to such transportation.

Now, that is the — and as I understand it, the only arguable exception to the integrity of the method because the method demands that all — the method won’t work with respect to carving out that aspect of gross income from mining unless the denominator in that fraction includes all of the costs and the multiplier includes the gross income from mining and since this taxpayer sold cement in bags and charged a price for it, that whole price has to be included because if — because if it isn’t, you — you don’t get — its an approximated method but the approximation you know starts to depart from the intended ambit of the depletion allowance which is to compensate for the exhaustion of the mineral deposit and not to — and not to provide any deduction for —

Byron R. White:

So, what is defining —

Stuart A. Smith:

— non-mining — non- mining activity.

Byron R. White:

Well, what if the taxpayer price list said, I’ll — I’ll sell cement to you either in bags or in gross for exactly the same price per hundred?

Stuart A. Smith:

For exactly the same price per hundred?

Then I assume — then I assume that you know people will either take it one way or another.

That — that doesn’t mean that the taxpayer is not making a profit.

All it means is that he’s selling bagged cement for — for less.

Byron R. White:

And so what if he had had a price list that says I’ll sell you bulk cement for $2 and bagged cement for $2.10?

So, it doesn’t make any difference what his price list is or what the cost of bagging.

Stuart A. Smith:

No, it doesn’t make any — well, it does make it, in your example, it makes a difference, but the point is that his gross sale of a — of his first marketable product in — in that — in the — in your latter example is either $2 or $2.10.

And we assume as the — as a —

Byron R. White:

And you — it wouldn’t make any difference to your case if it were stipulated that the cost of bagging was 20 cents, would it?

Stuart A. Smith:

It wouldn’t make any difference to me that the cost of bagging, and in fact it was — you know, essentially, that there was a disparity between the bagging premium and the bagging cost in this case.

But — but essentially all that means is that he’s selling the cement for less.

I mean we have to assume that this taxpayer sold bagged cement, and you know the Third Circuit more or less inferred that in Whitehall and though — and there’s an array of on the part of authority that rejects the notion that you can simply say, “Well, the bagging aspects of this thing are just an entirely different business and that we’re going to ignore them because it’s — because the regulations provide with explicit direction that the first marketable product is cement no matter — what — no matter how it’s packaged in either bulk or bagged form.”

If I can — can refer the Court to page 8(a) of our appendix which says here, “The first marketable product meets the product, produced by the taxpayer as a result of the application of non-mining processes in a form or condition in which such product or products are first marketed in significant quantities by the taxpayers.”

And then with specific reference to the cement industry, they say here, “For example, if the a cement manufacturer sells his own finished cement of various types in bulk and bags and also sells concrete blocks or dry ready-mixed aggregates containing additives, the finished cement of various types in bulk and bags constitutes the first marketable product.”

Byron R. White:

And your suggestion is that’s — that’s a permissible construction of the statute?

Stuart A. Smith:

Absolutely.

Byron R. White:

And that’s —

Stuart A. Smith:

Absolutely.

Byron R. White:

And if it isn’t, you lose, but if it is, you should win.

Stuart A. Smith:

I think we should win because — because the statute simply permits the Commissioner to — permits a reasonable allowance and also, this case has been made under regulations prescribed by the secretary or his delegate.

Now the — that’s a very broad delegation.

We view those regulations as legislative in type and this Court has held in cases which are legion that the Commissioner’s regulations are entitled to (Voice Overlap) —

Byron R. White:

What is the — what is the source of the language, first marketable product?

Stuart A. Smith:

What is the — I assume that the source of the first (Voice Overlap)

Byron R. White:

Is that in the regulations anywhere?

Stuart A. Smith:

Yes.

Byron R. White:

Is it in the statute?

Stuart A. Smith:

It is not in the statute but I assume that the —

Byron R. White:

So, the first marketable product is a product of the Commissioner’s mine?

Stuart A. Smith:

Based — based upon his reading of the — of this Court’s decision in Cannelton Sewer Pipe which talked about commercially marketable pipe.

Byron R. White:

Because isn’t that a little — isn’t it a little strange to say that — that there are three products that are the first marketable product even though bulk cement — you have to do something else to it to get it in the bags?

Stuart A. Smith:

Put it —

Byron R. White:

(Inaudible)

Stuart A. Smith:

— in the bag.

Byron R. White:

Well, I know —

Stuart A. Smith:

Yes.

Byron R. White:

— you have to do something else to it —

Stuart A. Smith:

Yes.

Byron R. White:

— to get it in the cement block.

Stuart A. Smith:

Oh — oh yes.

Byron R. White:

And it costs you money to do it and yet you say all three are —

Stuart A. Smith:

No, no.

That’s not what I said.

That the — the block is — is not the first marketable product.

Byron R. White:

You said it was.

Stuart A. Smith:

No, no, I didn’t.

He also — it says the finished cement of various types in bulk and bags constitutes the first marketable product but the blocks and the aggregates and the (Inaudible) or whatever, that’s a different product.

Byron R. White:

What about the — what about the bagged cement?

Stuart A. Smith:

The bags —

Byron R. White:

It costs him money if there’s a whole new — another process to go through to put in bags.

Stuart A. Smith:

Yes, Mr. Justice White.

Byron R. White:

And so how can there be two first marketable products?

Stuart A. Smith:

Of course there — no, there’s only one first marketable product, cement, no matter how it’s packaged.

Byron R. White:

I know that’s what you said.

Stuart A. Smith:

Yes.

Byron R. White:

There’s — there’s — although —

Stuart A. Smith:

Because in our view, bagging is not — is not a chemical or a physical process that adds — that — that alters the character of the — of the manufactured product.

The manufactured product is Portland Cement whether it’s in a railroad car, the Fifth Circuit stated this with excruciating detail, whether its in a railroad car or a piggyback or whatever, it’s still cement and if you put it —

William H. Rehnquist:

Well, Mr. Smith, is that consistent with the Tenth Circuit’s opinion at 14(a) of the petition down towards the bottom where the Court there says, “The Government seeks to have “bagged cement” be the “first marketable product” and to so include the expenses associated with the bag?

Does the Government take the same position?

Byron R. White:

Tenth Circuit —

Stuart A. Smith:

Oh — oh well, that’s really a mischaracterization of the Government’s position.

The Government argues that the first marketable product is finished cement no matter how it’s packaged.

I’m reading this most charitably, I would assume that what the Court meant is that the Government seeks to have bagged cement included in the first marketable product because it’s the — it’s the same cement.

It’s simply put in a bag.

Warren E. Burger:

Once — one answer might be that the reason you’re here is because the Tenth Circuit, from your point of view, did not understand the case.

Stuart A. Smith:

I think that’s right.

I mean, the — the Tenth Circuit took the position that bulk cement was the first product and bagged cement was the second product, but — the putting something in a bag is not the chemical or physical processing that the Court in Cannelton adverted to when it tried to fix the cut-off point as to when mining stops and when manufacturing begins.

And you know, put — the bagging is clearly part of the manufacturing cost but it goes into the sales of what this respondent and all other integrated producers sell as the first marketable product.

John Paul Stevens:

Mr. Smith, may I ask you a question prompted by some of Mr. Justice White’s question?

As I understand your position as a matter of fact (Inaudible) with the taxpayer as they made a profit on the bagged cement —

Stuart A. Smith:

Yes.

John Paul Stevens:

— and they wouldn’t sell it otherwise.

Stuart A. Smith:

Yes.

John Paul Stevens:

But the profit on the bagged cement is less than the profit on the other cement because the bags are more —

Stuart A. Smith:

Sure.

John Paul Stevens:

— costly than the bagging premium.

But is it not true that in your analysis of the case, even if they lost money on the bagging — the bagged cement, say, the bags were so terribly expensive, they packed them up in Christmas packages or something.

They lost money on the bags but you’d still make the same position —

Stuart A. Smith:

Sure.

John Paul Stevens:

(Voice Overlap) —

Stuart A. Smith:

It would have to — it would have to be included in the gross sales of the first marketable product and — then it would be — you know —

John Paul Stevens:

Yes, I —

Stuart A. Smith:

— it may — it may affect the — the amount of —

John Paul Stevens:

From your point of view, just as if they maybe had a price cut during February —

Stuart A. Smith:

Sure.

John Paul Stevens:

— and lost money for —

Stuart A. Smith:

Sure.

John Paul Stevens:

— three or four weeks the — you’d still use the same basic ingredients (Voice Overlap) —

Stuart A. Smith:

Exactly, exactly.

And went on — and — and the suggestion on the — the argument that I’m making is simply not one that’s based up upon regulations that we contend deserve great deference as legislative regulations.

The Court has held in a variety of depletion cases that the Commissioner has special powers in the depletion area because the legislative authority delegated the — the authority delegated to him is so broad, but in the — but — but the respondent is faced with an array of appellate decisions in which the court below is — stands as the sole exception that the first marketable product in this area is bulk and bagged cement.

That is, finished cement.

I would like — since the second question is a subsidiary one and I assume that costs necessarily, include in the denominator, flow from the first — from the first opinion I — from the first question, I would like to save my remaining time for rebuttal.

Warren E. Burger:

Well, just one more question.

Does your case really boil down and perhaps oversimplified, something like the difference between buying a loaf of bread in Paris where you put it under your arm, and buying one at the supermarket here where it’s all wrapped up in a package?

Stuart A. Smith:

Exactly, it’s the same bread.

And if there are tax deductions that — or computation that flow from — from that that involve gross sales, if the — if the supermarket in the United States has to sell some, has to raise the price to take into account the bag or if it doesn’t, that — those sales have to be included in gross sales.

Warren E. Burger:

Very well.

Stuart A. Smith:

And I would like to save the rest of my time for rebuttal.

Warren E. Burger:

Mr. Bedell.

Dennis P. Bedell:

Mr. Chief Justice, and may it please the Court.

The question in this case seems to have been cast in terms of preserving the integrity of a mathematical, automatically functioning formula, rather than in terms of preserving the integrity of the purpose for which that formula is being applied.

The purpose — the purpose is to ascertain an integrated miner’s gross income from mining.

Warren E. Burger:

Well, let — let me put it — let me put — I — I’m alternately confused in finding the case simplified.

When — when and what is it that can be first be sold?

What can first be sold here?

Dennis P. Bedell:

Bulk cement.

Warren E. Burger:

Yes.

Dennis P. Bedell:

And bulk cement —

Warren E. Burger:

Is — is the case any more complicated than that?

Dennis P. Bedell:

Not really.

That is — that is the product that is sold in a substantial quantity.

Dennis P. Bedell:

And indeed, as the Tenth Circuit has correctly recognized, bagging is something that occurs additionally and it has a discrete income component.

Warren E. Burger:

Well, this sounds as though you agree with Mr. Smith —

Dennis P. Bedell:

It is —

Warren E. Burger:

— which I (Voice Overlap) —

Dennis P. Bedell:

I do not agree with Mr. Smith.

Warren E. Burger:

It sounds as though you do, though.

Dennis P. Bedell:

No, there are —

Byron R. White:

You say bagged — you say bagged cement is not the — one of the first marketable products (Voice Overlap) —

Dennis P. Bedell:

I certainly do because bulk cement is sold in significant quantities.

Warren E. Burger:

More bulk than bag.

Dennis P. Bedell:

Indeed, approximately 95% in bulk.

John Paul Stevens:

Well now, what if the situation were reversed?

Dennis P. Bedell:

It is the first product reached.

John Paul Stevens:

Suppose there were more in bags than in bulk, only 1% of bulk, would your position here be exactly the same?

Dennis P. Bedell:

No, it would not because you have to have sufficient sales to establish the price so that you have a — a meaningful first marketable product.

Just as in the case of a representative field price at — where the product is sold after mining ends.

Byron R. White:

Where is that line of demarcation, 50%, 40%?

Dennis P. Bedell:

Cases in the depletion area under the representative market or field price generally are found at 10%, 15%, 20%.

It has to be determined with reference to the realities of the market.

Byron R. White:

What — what do you want it to — to be included in your gross sales figure, the multiplier there?

You — you just want the — yours — the — your gross sales of bulk cement in that or not?

Dennis P. Bedell:

The sales figures should include the gross sales of bulk cement and the sales value of the cement which is sold in bags because that also is the product of cement rock which was mined by the taxpayer and manufactured into finished cement.

Byron R. White:

So you’re saying that — you — you say along with Mr. Smith then that you include in the sales figure the — the cement sold in bags?

Dennis P. Bedell:

You have to include an income figure for cement sold in bags and the proportionate profit formula contemplates this because it takes actual sales of the first marketable product, sales of cement in bulk and with respect to products that are second or third, they further processed or product after first marketable product, they take a constructed sales value derived from the sales value applied to the first marketable product.

Thurgood Marshall:

You used the word process.

What was this process and put it in the bag?

Dennis P. Bedell:

It is the activity of putting it into a bag, Mr. Justice Marshall.

Thurgood Marshall:

And that does have a process, does it?

Dennis P. Bedell:

Not in the sense usually used in the depletion area, it is not.

William J. Brennan, Jr.:

(Inaudible) on the portion of the gross sales that represent product that was bagged, what is the constructive — the sales price that the taxpayer contended for?

William J. Brennan, Jr.:

Is it the equivalent of the unbagged cement or is it the actual price less the bagging cost?

Dennis P. Bedell:

The taxpayer took the — what is the less favorable position, namely, less favorable to itself or the actual sales price less the bagging cost because in this case, as the Court has noted, the bagging cost exceeded the bag premium, the additional revenue generated by selling the cement in bags rather than in bulk.

And so the taxpayer took sales figure of cement sold in bags, reduced that by the cost of bagging, which was greater really than the additional income generated by it.

And put that in the sales figure that then was allocated in accordance with the proportionate profits formula.

William J. Brennan, Jr.:

It doesn’t seem to me that’s consistent with your basic position that the sales cost is the cost of the unbagged cement.

I mean the sales price is the price of the unbagged cement?

It may have been good tactics to do it that way because I see what you’re saying but —

Dennis P. Bedell:

The —

William J. Brennan, Jr.:

— it’s somewhat inconsistent.

Dennis P. Bedell:

The taxpayer was following the law as had been set forth by the Tenth Circuit Court of Appeals in 1968 in the Ideal Basic case when it interpreted the manner in which the proportionate profits formula functioned in the case of a cement manufacturer.

William J. Brennan, Jr.:

Do you agree, by the way, that the Government’s position is the one that the regulation commands and so you must — you must attack the regulation?

Dennis P. Bedell:

No, I do not agree with that.

It seems to us that there is, within the regulation, room to find a result which is consistent with the purpose of the regulation.

The language Mr. Smith read to us which said that the bulk and packaged products are considered to be essentially the same product.

It doesn’t say they are.

It says they are considered to be.

That is language of — of presumption, not language of absoluteness.

And when a result occurs under regulatory language that clearly is at conflict with a purpose of the language, then seems to me that this language is susceptible of being interpreted in a manner as to cure the — the distortion which will result under Mr. Smith’s interpretation.

And indeed, I think that distortion should be focused on because it is material to — to realize the manner in which the purpose of the — applying the formula is being frustrated.

Now, let’s return momentarily, the purpose is to determine the gross income from mining.

That is the value of the taxpayer’s mineral that could have been realized had it been sold after mining process’s end.

So, we’re looking to a market value for the raw mineral product.

That’s the purpose for which the formula is being applied.

Warren E. Burger:

And when did the process end in your view?

Dennis P. Bedell:

The mining process ends at the point of kiln feed.

Warren E. Burger:

(Inaudible)

Dennis P. Bedell:

Well, that is introduced into the — the kiln, there is no dispute between the Government and the taxpayer with respect to that.

But the taxpayer’s cement rock under the Government’s interpretation would have one value if that cement rock was manufactured into finished cement and sold as bulk cement.

But a different value, the same identical mineral, would have a different value if it was manufactured into finished cement and sold in bags or looked at differently.

If in a given year, the taxpayer sold 5% of its cement rock in the form of finished cement in bags, the cement rock on an overall basis would have one value.

Dennis P. Bedell:

The next year it sells 20% in bags and the same cement rock from the same quarry, assume the same economic conditions, drops in value.

On the other hand, if it went down to zero instead of 7% it had here, the cement rock changes value.

Now, this — this is the identical mineral, which under the — the Government’s theory is having a change in value because of this bagging activity, an activity which occurs after all mining and all manufacturing processes have been completed.

Potter Stewart:

What — to echo my Brother Blackmun’s question, what if your client sold all of the cement in bags and always had and always will?

Dennis P. Bedell:

If the — all of the cement were sold in bags, bagged cement would be the first marketable product because what is being looked to —

Potter Stewart:

Bagging would clearly be part of the —

Dennis P. Bedell:

Then bagging would be part of the cost in arriving at that —

Potter Stewart:

All right.

Dennis P. Bedell:

— because what is being looked to is what is the point in the activity of getting to market when the taxpayer —

Potter Stewart:

But however, if a competitor sold all of cement in bulk?The — the difference of the mined product would be different between the two companies, wouldn’t it?

Dennis P. Bedell:

Under — under the —

Potter Stewart:

Or being identical product.

Dennis P. Bedell:

Under the proportionate profits formula, yes.

Warren E. Burger:

To carry it one —

Dennis P. Bedell:

And —

Warren E. Burger:

— step further, what if the industry as a whole sold largely or totally in bulk and this one manufacturer sold it just in bags?

Dennis P. Bedell:

There would be — because of the — the manner in which the formula, mathematical formula operates, there would be a different result.

Well, the question is in this case, there are actual facts.

Potter Stewart:

Right.

Dennis P. Bedell:

There are actual facts which can be looked to avoid what is an unrealistic result from the application of mechanical formula.

And that really is the question.

Can actual facts be taken into account?

The bagging cost and the amount of additional income because it is clear on the record that the taxpayer realized a certain increment of revenue when it sold cement in bags rather than in bulk, an additional amount of revenue.

Potter Stewart:

How is that different from, say, you have three or four methods of sales, some you sell through distributors and some on commission and some through door-to-door salesmen, and there are different sales costs per 10% of your business and another 20 and another 50, but it’s still all cement would use — and — and as those proportions vary from year to year, the value of the — of the mined product would also vary from year to year, as I suppose.

Would you say that nevertheless, those are — would you say that’s all one marketable product or does it — does it change from time to time?

Same as none of them was in bags but some of it was sold in smaller quantities at somewhat different prices because of different sales techniques.

How is that any different than the — the bagging problem?

Dennis P. Bedell:

One — since the — well, it seems to me it’s different in two reasons because in — in the first, there may be sales much closer to the — the manufacturing plant itself and so as they’re moved away from that —

Potter Stewart:

I’m leaving out transportation because I’m just focusing on sales costs.

Dennis P. Bedell:

The other — the other thing is that sales costs.

Dennis P. Bedell:

Sales costs are costs which a number of the courts said they’ve looked at it, the lower courts, have decided are costs allocable both to the mining and the manufacturing activity.

Potter Stewart:

Well, that’s exactly —

Dennis P. Bedell:

And so they —

Potter Stewart:

— like — like they say the bags are —

Dennis P. Bedell:

— they allocate —

Potter Stewart:

— allocated to both, too.

Dennis P. Bedell:

They allocate them — well, the — the Government though, under its interpretation of the formula would allocate the cost of bagging solely, solely to the manufacturing non-mining side.

William H. Rehnquist:

Well, Mr. Bedell —

Potter Stewart:

That goes into the total figure, doesn’t it?

Just as the sales costs go into the total figure.

And maybe I’m wrong, but I thought —

Dennis P. Bedell:

Well, the — the manner in which —

Potter Stewart:

Let’s say in the general sales manager.

How — what is the — to his salary?

Dennis P. Bedell:

The salary of a general sales manager should be treated as both in the numerator of the formula and in the denominator.

Potter Stewart:

Is that what you did in your tax return?

Dennis P. Bedell:

Again, following the Tenth Circuit, the Tenth Circuit interpretation or —

Potter Stewart:

Well, yes or no, did you or did you not?

Dennis P. Bedell:

No, because that is not the manner in which the Tenth Circuit interprets it.

William H. Rehnquist:

If — if one reads the statutory language itself, the 611(a), the general rule in talking about mines, it says that the allowance for depletion, for depreciation 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, is it conceivable in — in view of that reference to peculiar cases that the numerator or denominator were worked out by the — could itself be unreasonable in some cases?

Dennis P. Bedell:

Exactly, exactly.

It is contemplated by the — the statute not only by the language that it’d be reasonable but that it take into account the variations in different cases.

Obviously, administrative convenience and simplicity require ignoring some variations, but when you have variations that are supported by definite facts such as in this case, peculiar circumstances is what we have here, and ascertainable income item and ascertainable costs associated with the bagging activity, then that is the type of case which it should be dealt with, and indeed that is what the Tenth Circuit has consistently held that the Ideal Basic case in 1968, the Portland Cement Company of Utah case in 1969, and then in this case.

Because the — of this actual fact, it is a factor which can be taken into account and supports the determination as the Tenth Circuit has held that the first marketable product was cement in bulk.

The — the confusion between the premise, the premise of the proportionate profits formula and the purpose which it serves of trying to find gross income from mining has clouded the issue in — in many — that the context has been looked at up to now.

There is distortion which occurs if additional processes farther away from the crude mineral product which is being valued are taken into account.

The Tenth Circuit realized that and the Tenth Circuit because it realized that the purpose of the proportionate profits formula is to value the mineral product found a place closest to the mine, closest to the point where the mineral product is, and that is cement in bulk and treated that as the first marketable product so that it was the starting point for the application of this mathematical formula.

To ascertain the market value, it did away with the recognized distorting effects which occur if additional activities on which a profit is not earned are — are included in the computation in the same manner — in the same manner as the regulations explicitly recognized with respect to purchased transportation.

Purchased transportation by common carrier to the customer to deliver the material to the customer is specifically excluded.

Why?

Dennis P. Bedell:

Because there is a reason.

It is not reasonable to presume that the miner earns a profit on the transportation because the carrier earns it.

The evidence of a tariff demonstrates that.

Here, the facts, the evidence of the bagging premium and the bagging costs demonstrate that it is not appropriate to attribute any further profit to the bagging activity, and so the Tenth Circuit excluded that from the computation in a similar manner by its determination that the first marketable product is cement in bulk.

The — the result of making the proportionate profits method work in the best manner it can to serve its purpose can be accomplished as the Tenth Circuit did or by finding implicit in the regulatory language, flexibility, to make its application a reasonable one, one consistent with the actual facts.

I thank the Court.

Warren E. Burger:

Very well.

Mr. Smith, do you have anything further?

Stuart A. Smith:

I think that the respondent’s emphasis on — on actual facts is — is belied by the — by the provisions of the regulations which provide that if — that the Commissioner may determine that a method of computation is more appropriate than the proportionate profits method or the method being used by the taxpayer and that the taxpayer can request such a determination of an alternative method.

Here, the taxpayer has, because of its integrated status, and the absence of a — of a representative field price has invoked the proportionate profits method of computing its gross income from mining.

It hasn’t sought to bring any actual facts to the Commissioner before — before going into this litigation.

The proportionate profits method provides in detail the — the language I read to the Court about a cement manufacturer.

When we talk about flexibility of the regulations, the regulations provide at page 21(a) of our appendix with precise reference to this case, “If a cement manufacturer,” et cetera, et cetera there is no room for any flexible reading.

What the respondent seeks in this case is nothing less than an invalidation of these regulations which three Courts of Appeals have approved and which the court below stands in sole and persistent invalidation of.

And there’s no way that one can read these regulations in a flexible way to take account of what this — of what respondent seeks in this case, which in our view, is nothing less than an expanded depletion allowance that would include part of its non-mining income.

The cost ratio method is indeed an — an approximation, but it is an approximation which is designed to take into account the fact that each dollar of costs produces a proportionate amount of — of gross sales —

Potter Stewart:

Well, that — that in itself is something of a fiction.

Stuart A. Smith:

Well, of course, it’s a —

Potter Stewart:

Or at least (Voice Overlap) —

Stuart A. Smith:

— of course, it’s a fiction but it’s an approximation —

Potter Stewart:

Right.

Stuart A. Smith:

— which is based upon the fact that there’s no really better way to do it, and regulations like that, the choice that the Commissioner makes in — in areas like a technical area like depletion, and in other areas of the code have been consistently upheld by this Court —

Potter Stewart:

And in —

Stuart A. Smith:

— and by the courts as basically —

Potter Stewart:

And your point is that this taxpayer elected to (Voice Overlap ) —

Stuart A. Smith:

Elected the proportionate profits method and you can’t simply elect parts of the proportionate profits method.

Putting a cement — putting cement in a bag is, in our view, and in the view of the regulations, not processing.

It doesn’t alter the character of the cement.

The cement, whether it’s in a tank car or whether it’s in a bag, is still Portland Cement.

That was the respondent’s first marketable product and it’s the gross sales of those things.

Stuart A. Smith:

If the — if the taxpayer had sold Portland Cement at a great killing, at a very high price, whether — it would still be in gross sales and it was a — you know, it may produce some variations or some distortions, or if the market goes down, it would still be in gross sales.

And the fact that, you know, it sought to satisfy a particular kind of demand of a small — of small customers in this — in the construction industry for 94-pound bags of cement, that was part of its business.

And if it’s part —

William J. Brennan, Jr.:

Would you —

Stuart A. Smith:

— of its business —

William J. Brennan, Jr.:

Would you say if for the same reason that sales expense after bagging is included?

Stuart A. Smith:

The sales expense after bagging to get it to the customer is a — is — goes into the denominator.

William J. Brennan, Jr.:

For the same reason?

Stuart A. Smith:

Exactly.

William J. Brennan, Jr.:

For the same reason?

Stuart A. Smith:

Exactly.

And for — and for all those purposes we think the reason — the judgment should be reversed.

Warren E. Burger:

Thank you, gentlemen.

The case is submitted.