Parsons v. Smith

PETITIONER:Parsons
RESPONDENT:Smith
LOCATION:Union Station

DOCKET NO.: 218
DECIDED BY: Warren Court (1958-1962)
LOWER COURT: United States Court of Appeals for the Third Circuit

CITATION: 359 US 215 (1959)
ARGUED: Mar 04, 1959
DECIDED: Apr 06, 1959

Facts of the case

Question

  • Oral Argument – March 04, 1959 (Part 2)
  • Audio Transcription for Oral Argument – March 04, 1959 (Part 2) in Parsons v. Smith

    Audio Transcription for Oral Argument – March 04, 1959 (Part 1) in Parsons v. Smith

    Earl Warren:

    Number 218, Emory W. Parsons, et al., Petitioners, versus Francis R. Smith, Former Collector of Internal Revenue for the First District of Pennsylvania.

    And Number 305, George Huss, et al., Petitioners, versus Francis R. Smith, etcetera.

    Mr. McDowell you may proceed.

    Sherwin T. McDowell:

    May it please the Court.

    In view of the consolidation of these cases, counsel for the petitioners have agreed that each will speak for 25 minutes, reserving with the permission of the Court 10 minutes of the allotted time for rebuttal argument after respondent presents his case which will be made by Mr. Berger.

    These cases involved the right of coal operator —

    Earl Warren:

    I suggest you keep track of your own time —

    Sherwin T. McDowell:

    Yes, sir.

    I understand that we have.

    Earl Warren:

    — because we can’t do that for you.

    Sherwin T. McDowell:

    Thank you, sir.

    These cases involved the right of coal operators engaged in the business of strip mining coal to present its depletion under the Internal Revenue Code.

    This is not only the first case involving strip miners to come before the Court, but to our knowledge, it is the first case ever to come before this Court in which the right of the person actually producing the minerals to depletion was ever challenged.

    The facts in both cases are essentially the same.

    I will state the facts in the Parsons case and due to the extent there are differences, Mr. Berger will state them in the Huss case.

    Perhaps it would be helpful to consider briefly the operation known as “strip mining.”

    A strip miner mines from the surface of the earth.

    Unlike a deep miner, he does not drive shafts into the earth to reach the coal.

    Basically, the operation is performed by removing the earth which lies over the coal known as “overburden.”

    This overburden is removed by making massive cuts in the earth.

    The overburden from one cut being deposited into the adjacent cut from which the coal has already been removed.

    The operation resembles to a degree plowing a field except that the furrows may be as much as 200 feet deep.

    Strip mining of course, is feasible only where the coal does not lie at too great a depth beneath the surface, and also the thickness of the seam of coal has a bearing because it is profitable to remove more overburden to reach a thick seam than a thin one.Seams of coal do not lie or run at a uniform depth beneath the surface.

    They may crop, fault or pitch.

    Coal crops when it comes to the surface of the earth.

    It faults where the vein is cut off beneath the surface usually by a rock upheaval, and it pitches where it goes into the earth at a sharper incline.

    The overburden is removed in several ways, by scrapers which are the ordinary road scrapers with which one is generally familiar by high-lift shovels which are basically the standard form of steam shovel with a little longer boom to enable the bucket of the shovel to be raised to a greater height.

    In other words the high-lift shovel in effect digs itself down into a hole in order to reach the coal.

    And lastly, coal is removed — overburden is removed by the use of draglines.

    These vary in size but basically, they’re all the same.

    Sherwin T. McDowell:

    They operate on the same principle.

    They consist of a machinery housing and a long boom perhaps 60 to 135 feet from which is suspended a huge bucket by a cable.

    This bucket is capable of removing great quantities of earth at one scoop.

    To what extent is the equipment that you use you need for strip mining?

    Sherwin T. McDowell:

    Well, sir —

    As distinguished from its use — usability and generally in other types of operation?

    Sherwin T. McDowell:

    Well, I think a fair answer to that, sir, would be that bulldozers, scrapers, trucks may generally be used in — in road building and in other instances where it is necessary to remove quantities of earth.

    A dragline is generally limited to a stripping operation, although where it would be necessary to remove great quantities of earth in a road building operation, I presume that a dragline would be used for the purpose.

    Draglines are customarily used in coal stripping because of the fact that they do remove great quantities of earth with one scoop or bite, and also because they can work at practically any depth because of the fact that their limitation really is only the extent of the cable —

    William J. Brennan, Jr.:

    You’ve defined things so well.

    Would you define the dragline?

    Sherwin T. McDowell:

    Sir?

    William J. Brennan, Jr.:

    The dragline.

    Sherwin T. McDowell:

    A dragline?

    William J. Brennan, Jr.:

    So it’s just — is that the word — that was used?

    Sherwin T. McDowell:

    Yes, sir.

    D-R-A-G-L-I-N-E.

    William J. Brennan, Jr.:

    What’s that?

    Sherwin T. McDowell:

    Well, I — I think, if I may, that the definition comes from the fact that there’s a long boom with a cable and a bucket is suspended from it.

    The bucket is dropped into the hole in the earth.

    The machinery draws it back up.

    In other words, it drags it up on the —

    William J. Brennan, Jr.:

    It’s all a (Voice Overlap) —

    Sherwin T. McDowell:

    — cable line.

    William J. Brennan, Jr.:

    Okay.

    Sherwin T. McDowell:

    Once the overburden has been removed exposing the coal, the coal is cleaned, loosened and placed usually by dynamiting so that it may be removed from the vein.

    This removal is accomplished by placing a loading shovel, which is generally a steam shovel on the coal in place bringing trucks down into the cut and loading the trucks with the steam — with the steam shovel.

    It’s obvious of course, that roads must be built for this operation not only to enable the strip miner to move his heavy-duty equipment in but also to enable the coal to be hauled out in trucks.

    In the Parsons case, the partnership Parsons mined the coal under an oral contract with Rockhill Coal Company, the owner of the land.

    This contract, is what is known in the industry as a salvage contract, that is to say, Parsons bore all the expenses of the operation and furnished the equipment and received payment only if it was successful in discovering and extracting marketable coal.

    Sherwin T. McDowell:

    Parsons was paid a stated price per ton by the coal company on whose lands they were operating.

    The contract was terminable on 10 days notice by either party, but if the contract was terminated, Parsons had the absolute right to remove and be paid for all coal which he had uncovered even though that took more than 10 days.

    Parsons had the exclusive right strip areas allocated to it.

    Parsons controlled the amount of equipment, the number of workers used in the job, and the quantity of coal to be stripped.

    The value of the equipment used on the job by Parsons ranged from $60,000 in the four-part of the operation to as high as $250,000 in the latter part of the operation.In fact, Parsons’ agreement was never terminated by the landowner.

    Parsons stripped on the landowner’s land continuously for over eight years.

    The stripping ended when Parsons gave the landowner notice that it intended to cease operations after 30 days if that was satisfactory.

    The right to terminate, was it mutual (Inaudible)

    Sherwin T. McDowell:

    Yes, sir, it was mutual.

    After giving the notice which — 30 days which was satisfactory to the landowner, Rockhill, Parsons ceased operation about five weeks later, which was the time required to remove the coal it had been cleared of overburden.

    The petitioners brought suit upon rejected claims for refund of federal income tax for the years 1945 through 1949.

    The District Court and the Court of Appeals for the Third Circuit concluded that they were not entitled to depletion and it is this conclusion which is before this Court for review.

    At the outset, I think it is important to note that the petitioners here seek only a share of the depletion, not all of it.

    This is so because the statute provides for a deduction of a — for depletion in the form of a flat percentage of gross income from the property which is defined as the gross income from mining.

    There is no dispute here as to the gross income from mining.

    The dispute is whether the strip miner who mined the coal is entitled to percentage depletion on his share of that gross income from mining.

    Assume, for example —

    Earl Warren:

    What is that share, Mr. — as you see it, Mr. —

    Sherwin T. McDowell:

    That share is the price per ton he received from the landowner for the coal.

    In other words, his gross income from mining, Your Honor, would be — if he will pay $1.50 a ton as he was here the price was varied upward, but his gross income from mining in respect of that ton of coal would be what he was paid for it.

    What would be the share the owner would get?

    Sherwin T. McDowell:

    Well, perhaps I could handle that by an example, sir.

    A little easier than using the actual figures but the principle is the same.

    Let us assume that the landowner sold the coal for $4 a ton.

    Now, that’s the gross income from mining because at that point, the coal goes off the market.

    Let us also assume that the landowner paid the strip miner who mined the coal $2 a ton.

    The question is whether the landowner is entitled to percentage depletion on $4 and the strip miner nothing.

    Or whether the strip miner is entitled to depletion on $2 which is his gross income and the landowner on the remaining $2 of the gross income from mining after deducting what he has paid the strip miner for the coal.

    So that it is a question of sharing the depletion not endeavoring to increase the depletion dollar above $1 —

    William J. Brennan, Jr.:

    (Voice Overlap)

    Sherwin T. McDowell:

    I beg your pardon, sir?

    William J. Brennan, Jr.:

    (Inaudible) — what did he get — on your example, did he get it on $4 or $2 or —

    Sherwin T. McDowell:

    Yes, Your Honor.

    We are informed that he got it on $4 in my — using my example.

    William J. Brennan, Jr.:

    Yes.

    Potter Stewart:

    So the — the total amount of depletion, of the — of the depletion deduction would be the same in either case.

    It would be 5% of $4.

    Sherwin T. McDowell:

    Yes, sir, that is right.

    Potter Stewart:

    So that assuming that — which is the —

    Sherwin T. McDowell:

    And all we ask is a share of the 5% of $4.

    Potter Stewart:

    Which would make sense, I guess.

    Sherwin T. McDowell:

    We’re not asking — I beg your pardon, sir?

    Potter Stewart:

    If my arithmetic is right, that’s 20 cents —

    Sherwin T. McDowell:

    20 cents, yes, sir.

    Potter Stewart:

    Not — and the only question is whether you take a dime of the depletion per ton and the owner takes a dime, or whether he gets full 20 cents.

    Sherwin T. McDowell:

    That is precisely it, sir.

    Potter Stewart:

    And then —

    Sherwin T. McDowell:

    But it will never be more than 20 cents.

    Potter Stewart:

    Right.

    Sherwin T. McDowell:

    Now however —

    Potter Stewart:

    It’s more than 5% of the gross income.

    Sherwin T. McDowell:

    That is correct.

    Potter Stewart:

    Now, did that —

    Sherwin T. McDowell:

    That’s how the pie is cut up.

    Potter Stewart:

    So, generally speaking, the — the Government’s position here is that of a stakeholder except insofar as the owner and the — and the strip mine contractor, whatever — whatever your client is called, might have different — might be taxed to different rates, is that right?

    Sherwin T. McDowell:

    Yes, that is — that is essentially correct, sir.

    Earl Warren:

    Suppose —

    (Inaudible)

    Earl Warren:

    Oh, pardon me?

    Suppose your — your client employed an independent contractor to do a certain portion of his — his job such as the trucking or loading cars or something of that kind, would he be entitled to a share of the depletion?

    Sherwin T. McDowell:

    In our view of the case, he would not, Your Honor, for the reason that he would not be engaged in mining.

    We were engaged in mining but someone that may be hired as an employee or may perform part of the process subsequent to the actual mining is not engaged in mining and therefore would not be entitled to depletion.

    Earl Warren:

    Well, then if — if that portion of your — of your obligation under the contract is not mining, how would you be entitled to a depletion?

    Why should you be entitled to a depletion for that portion of your — of your work?

    Sherwin T. McDowell:

    Well, because the statute Your Honor does not — does not require a division of the portion of the work that is performed.

    If we are in the business of mining, we derive gross income from mining by the whole of the operation that we perform.

    And our gross income from that Your Honor is as we see it, what we get paid per ton for the coal which we deliver after we discover it.

    Earl Warren:

    Where there is mining or not?

    I mean, on those parts of the operation, your operations that are not mining, you’re entitled to — according to your theory, you’re entitled to depletion on that the same as you are on the portion that does constitute mining?

    Sherwin T. McDowell:

    Well, I — if I may put it this way, Your Honor, I think it is all mining for two reasons.

    One, as a matter of fact, that is to say that delivering the coal to the tipple is part of the mining but beyond that there is a very elaborate statutory definition of the process of mining which includes a number of treatment processes going beyond the actual process of digging the coal out of the ground so that on either score, as I see it, the whole of it would be mining, the whole of what we did.

    Earl Warren:

    But if you parceled any of that out to anybody, it — they would not be entitled to any depletion.

    Sherwin T. McDowell:

    Well, I would have some hesitancy to making of a — a flat agreement because I think that it would depend in part on how that was done.

    But to the extent it was done simply by virtue of our engaging somebody to perform part of it, my answer would be, “Yes, sir.

    They are not entitled to — to depletion.”

    Now, of course whether the strip miner is entitled to this share of depletion we seek depends upon whether he has under the decisions of this Court an economic interest in the coal in place.

    First, we should observe that economic interest does not mean legal title to or ownership of the coal.

    Indeed, the term “economic interest” includes, as this Court has held in Palmer against Bender, every case in which the taxpayer is acquired by investment, any interest in the mineral in place and secures by any form of legal relationship income derived from the extraction of the mineral to which he must look for a return of his capital.

    This principle was most recently restated by this Court in the Commissioner versus Southwest Exploration Company.

    In that case, a — an oil operator, got a lease from the state to drill for offshore oil.

    As required by a state law in the absence of an artificial — a natural or artificial drilling island from which he could drill, he secured the right from the adjacent upland owners to erect drilling equipment on their lands and by the process known as “whipstock drilling” reach the offshore oil.

    He agreed to pay the upland owners a stated percentage of his net profits for the right to use their land.

    The issue before this Court was whether the upland owners had an economic interest in the offshore oil.

    This Court held that they did, that the upland owners’ contribution, their land, was an investment in the oil in place sufficient to establish their economic interest.

    Their income was dependent solely upon production and the value of their interest declined with each barrel of oil produced.

    Wasn’t — wasn’t that a situation in which the taxpayer who — the landowner had land which was — could only be used — there wasn’t any other land that could be used for this offshore drilling, was it?

    Sherwin T. McDowell:

    Well, if I might answer that this way, Your Honor.

    Actually, there were contracts made there in that case with five upland owners.

    Actually, the land of only three were used to reach the oil so that — I think it is fair to say that while the upland owners were essential as a class, no single one of them was essential to — to make it possible for the oil deposit to be reached.

    The requirements as we stated in the Southwest case may be summarized as follows.

    Sherwin T. McDowell:

    There are three.

    First, the taxpayer must apply by investment an interest in the mineral in place.

    Second, he must derive income solely from production.

    And thirdly, his interest must decline with production.

    The petitioners here urged that we meet precisely these requirements.

    First, by the contracts, we acquired an interest in the coal namely, the right to mine it, and be paid for it.

    This interest like the interest of the upland owners in the Southwest case was essential to the mining operation.

    Charles E. Whittaker:

    Can I ask you as to their —

    Yes, sir.

    Charles E. Whittaker:

    (Inaudible) the coal and the right to be paid for it.

    Now, what do you mean, paid for the coal or for the mining?

    Sherwin T. McDowell:

    The right to be paid for the coal, Mr. Justice Whittaker, when after we mined it.

    In other words, we took the risk of discovery and after we got marketable coal above the ground and delivered it to the landowner, we were paid for that coal.

    So I was — when I said “it” I meant coal.

    Yes, sir.

    Charles E. Whittaker:

    Do you have any title as such to the coal?

    Sherwin T. McDowell:

    No, sir.

    We had no title as such to the coal.

    Charles E. Whittaker:

    And now do you get paid for the work, were you not?

    Sherwin T. McDowell:

    No, sir.

    I do not think we were being paid for work because you have to have regard for the circumstance under which this arrangement arises.

    In other words, we received absolutely no pay unless, under the salvage contract, unless after furnishing all of the equipment and doing all of the work we found coal that was marketable and delivered it to the owner.

    Our position is that the contribution of the strip miner who does the mining is equally essential — equally as essential as the contribution of the landowner —

    William J. Brennan, Jr.:

    May I ask you as to the —

    Sherwin T. McDowell:

    Yes.

    William J. Brennan, Jr.:

    Do you put any label to that interest?

    Sherwin T. McDowell:

    I beg your pardon?

    Hugo L. Black:

    You put any label on this (Voice Overlap) —

    Sherwin T. McDowell:

    To the contribution?

    William J. Brennan, Jr.:

    To the interest that you acquired?

    Sherwin T. McDowell:

    No, sir.

    I — my answer would be, I don’t think a label is necessary because the Court has said by any equal relationship and we were not trespassers.

    We were in there as of right so that I don’t know that it’s necessary to define the — the — by label the right that we had under our contract.

    I would not regard it as important to do that, Your Honor.

    William J. Brennan, Jr.:

    Well I — I’m thinking about Mr. Justice Whittaker’s question to you.

    You said that you had “an interest” in the coal as I understood it, is that right?

    Sherwin T. McDowell:

    Yes, sir.

    William J. Brennan, Jr.:

    An interest in the coal.

    Sherwin T. McDowell:

    Yes, sir.

    Our position is that we had an interest in the coal in the same — in the same way in which the upland owners in the Southwest case were regarded as having an interest in the offshore oil that was out beyond their — the actual line of their ownership.

    Charles E. Whittaker:

    (Inaudible)

    Sherwin T. McDowell:

    Yes, sir.

    Charles E. Whittaker:

    (Inaudible)

    Sherwin T. McDowell:

    Well, Mr. Justice Whittaker, I think the answer is this, that the Court held that the upland owners had an economic interest in the oil in place.

    There is a — there is a quotation from the Southwest case which I think is —

    Charles E. Whittaker:

    (Inaudible)

    Sherwin T. McDowell:

    All right.

    But you will find in there, sir, a statement to the effect because under the law as it has developed in this Court under these economic interest decisions, the ultimate conclusion is that the man who has a depletable interest has an economic interest in the mineral in place.

    The second requirement of the three I summarized, namely, that our income must be dependent upon production is clearly met here, and as we understand it, the respondent has conceded that.

    And the third requirement, namely, that the interest must decline in value as the coal is exhausted is likewise met here because with each ton of coal removed, the strip miners were that — there remained that much less coal from which the strip miners might thereafter derive income.

    We believe that perhaps an apt way of demonstrating our position that the strip miners in this case had an economic interest in the coal in place is to paraphrase the words of this Court in the Southwest case and substitute the word “strip miners” for the word “upland owners” as used in that case.

    Here, the strip miners chose to contribute their organization and equipment to the coal-stripping venture in return for income based upon production.

    This contribution was an investment in the coal in place sufficient to establish their economic interest.

    Their income was dependent entirely upon production and the value of their interest decreased with each ton of coal produced.

    No more is required by any of this Court’s decisions.

    Hugo L. Black:

    In my recollection directly, they were indispensable to this — to the work they’ve done there and their property was indispensable —

    Sherwin T. McDowell:

    Well, Mr. Justice Black, their property was indispensable as a class and if — if I may — if I may, sir —

    Hugo L. Black:

    Well, could it have been produced without excess to and from their property?

    Sherwin T. McDowell:

    As a practical matter, no, because it would’ve been too expensive, apparently.

    Hugo L. Black:

    You, in your case.

    Sherwin T. McDowell:

    Yes, sir, we — it takes a coal stripper to —

    Hugo L. Black:

    I understand that.

    Sherwin T. McDowell:

    — produce this coal.

    Hugo L. Black:

    There, this was a part of the setup itself.

    It was a — he had an asset there and that he was a part of it just as much as though he was —

    Sherwin T. McDowell:

    Well —

    Hugo L. Black:

    And there are other men on — over — on that land.

    Sherwin T. McDowell:

    Except this one — this one fact, sir, which I understand from the case there were five upland owners from whom drill sites were secured and ultimately, wells were drilled on the land of three, so that the oil deposit to the extent of the oil operator desired to reach it was reached from the land of three not the original five upland owners.

    Tom C. Clark:

    Upland owners though was a party to the lease arrangement.

    Sherwin T. McDowell:

    As I understand it — as I understand it, Mr. Justice Clark, he was not a party to the lease arrangement which the oil operator made with the state.

    The record in that case, I believe, discloses that it was stipulated indeed that he had no interest in that lease.

    Tom C. Clark:

    The endorsements though in the application (Inaudible)

    Sherwin T. McDowell:

    Well —

    Tom C. Clark:

    The thing is he was going to press the land which is necessary —

    Sherwin T. McDowell:

    Yes, that —

    Tom C. Clark:

    — if the State gave it.

    Sherwin T. McDowell:

    That is — that is correct sir, because as I understand that the State required him or required the oil operator to demonstrate that he had a drill site, so he brought his agreement in.

    Hugo L. Black:

    He owned the part of the assets as I recall it.

    I have read it.

    He owned the part of assets which were indispensable for the production of that oil.

    And the more oil that is produced, the less his land would be worth, so it’s wasted away.

    Sherwin T. McDowell:

    But of course you understand, Mr. Justice Black, that he didn’t sit over and owned any of the oil as such.

    Hugo L. Black:

    I understand that.

    Sherwin T. McDowell:

    His land was here and the oil was offshore.

    Hugo L. Black:

    He owned the part — he owned the part of the property that was indispensable for the production of the oil.

    Suppose if — if the company had owned all that, they would’ve used it just as it did.

    Sherwin T. McDowell:

    Yes, sir.

    Well, I — that is — that is — that is correct.

    He — he owns something which in those —

    Hugo L. Black:

    He — he actually sustained a law in connection with the assets that were utilized both for the production over the properties.

    Sherwin T. McDowell:

    But we maintain, Your Honor, that we did here too because with each ton of coal produced, our right to produce coal under this arrangement necessarily declined.

    Hugo L. Black:

    What about a coal miner?

    Sherwin T. McDowell:

    You mean an — well —

    Hugo L. Black:

    You have the coal miner.

    Sherwin T. McDowell:

    Well,

    Hugo L. Black:

    — he — he have an interest to that extent, wasn’t it?

    Sherwin T. McDowell:

    No, sir.

    A coal miner would be, in our view of the matter, Mr. Justice Black, an employee, he would not be engaged in the business of mining for his own account as these strip miners were.

    Hugo L. Black:

    If it was his own account, he’d get some wages for that.

    Sherwin T. McDowell:

    Well, if — well, to that extent, yes, right — right so.

    Hugo L. Black:

    He loses that interest.

    If he loses — if there — all that’s depleted, he loses his job.

    Sherwin T. McDowell:

    Yes, but he is not deriving gross income from mining sir, in the sense that he is engaged in the business of mining as an entrepreneur.

    He’s an employee.

    Right.

    That — that would be a valid distinction.

    Sherwin T. McDowell:

    I would like to make just one point, if I may, and that is with respect to determination clause in this contract.

    I direct the Court’s attention to the fact that it was under our contract agreed that if 10-days notice was given, Parsons had the absolute right to take out all the coal it had been uncovered irrespective of how long that required.

    So that as to the coal which was actually removed and the coal with respect to which depletion is sought, our contract in fact was not terminal because the minute the overburden was removed, that coal was coal which could not be taken away from us by termination and that was coal which we had the absolute right to take out, and sell to the landowner for the stated price.