General Portland Cement Co. v. U.S.

Decision Date10 October 1980
Docket NumberNo. 77-2831,77-2831
Citation628 F.2d 321
Parties80-2 USTC P 9720 GENERAL PORTLAND CEMENT CO., Plaintiff-Appellee Cross-Appellant, v. UNITED STATES of America, Defendant-Appellant Cross-Appellee.
CourtU.S. Court of Appeals — Fifth Circuit

Kenneth J. Mighell, U.S. Atty., Fort Worth, Tex., Martha J. Stroud, Asst. U.S. Atty., Dallas, Tex., David E. Carmack, Gilbert E. Andrews, Acting Chief, App. Section, M. Carr Ferguson, Asst. Atty. Gen., Tax Division, U.S. Dept. of Justice, Washington D.C., Grant W. Wiprud, Atty., Tax Div., Francis J. Blanchfield, Jr., Dept. of Justice, Washington, D.C., for defendant-appellant cross-appellee.

Buford P. Berry, Emily A. Parker, Dallas, Tex., Michael J. Roach, Washington, D.C., for plaintiff-appellee cross-appellant.

Appeals from the United States District Court for the Northern District of Texas.

Before GOLDBERG, FAY, and ANDERSON, Circuit Judges.


In this case General Portland Cement Co. (sometimes referred to as taxpayer) filed suit for refund of federal income taxes and assessed interest for the years 1960 through 1968 in the total amount of $2,178,046.42.

All of the issues before this court involve the percentage depletion deduction allowed by Section 613 of the Internal Revenue Code of 1954, as amended, 1 and all except the interest issue involve the proportionate profits method. The issues are: (1) the proper treatment under the proportionate profits method of certain items: the bagging premium and the costs of the bagging operation, and the costs of loading bulk cement and other distribution costs; (2) the proper treatment under the proportionate profits method of the discount offered by taxpayer to its customers for prompt payment; and (3) the proper treatment of certain items of interest income and expense in calculating the "50% limit." 2 The district court's decision, reported at 438 F.Supp. 27, sustained the government's position both with respect to the treatment of the cost of loading bulk cement and other distribution costs and with respect to the treatment of the bag premium and the costs of the bagging operations. With respect to these items, we affirm. The district court held for the taxpayer with respect to the proper treatment of the discount; we reverse that holding. The district court also held for the taxpayer on the interest issue; with respect to that issue, we affirm.

Part I of this opinion will set out certain details concerning the manufacture of cement which we hope will contribute to an understanding of the issues. Part II will explain the mechanics of the percentage depletion deduction and the proportionate profits method. Parts III, IV, and V discuss respectively the three issues listed above. The facts relevant to each issue are set out in the part of the opinion discussing that issue.


Taxpayer is an integrated mining and manufacturing company producing cement. In the production of cement, taxpayer generally extracts limestone (source of calcium carbonate), shale, and/or clay (source of silica, alumina and iron). These minerals are conveyed to a primary crusher which crushes the minerals. The crushed mineral is stockpiled near the cement plant along with other necessary minerals, which are either purchased or extracted from taxpayer's quarries. These materials then undergo a raw grinding process in which water is added to make a mixture having the appearance of mud. The product of this raw grinding process is called "slurry." The slurry is then pumped to large blending and storage tanks where it is continually agitated to keep the solids from settling and to keep the mixture homogeneous. The slurry is then moved from the blending and storage tank as "kiln feed" into a large rotary kiln where it is burned. Complex chemical reactions occur in the kiln, and a cement clinker results from this burning process. The cement clinker is cooled, and later the clinker, along with gypsum, is ground into finished cement. The finished cement is then conveyed to storage silos at the plant where it is stored until it is shipped by rail, barge, or truck, either directly to taxpayer's customers or to distribution terminals operated by taxpayer in cities other than those where taxpayer maintains plants. When cement has been transported to a distribution terminal, customers may take delivery there or it may be shipped to them from there. Taxpayer loads the bulk cement from the storage silo, located either at the plant or at a distribution terminal, directly into rail cars, barges, or trucks for shipment.

Approximately 10% to 20% of taxpayer's sales are in bags, rather than in bulk. Upon receiving an order for bagged cement, the finished bulk cement is conveyed from the storage silo to a bagging machine. After the bag is filled according to weight, the bagged cement is hand loaded onto a truck or rail car for shipment to the customer.


The percentage depletion deduction provided by Section 613 is calculated by multiplying "gross income from mining" by the applicable rate. 3 If taxpayer mined his mineral and sold it in crude form at the mine, his "gross income from mining" would simply be his gross sales price. However, when a taxpayer uses his crude mineral in a manufacturing operation, he has no sales price for the mineral itself. The sales price of the manufactured product cement in this case cannot be used, because to do so would give the taxpayer an inflated deduction based on the price of the manufactured product, which includes the value of the crude mineral plus the value added by the manufacturing processes. The purpose of the percentage depletion deduction is to compensate a taxpayer for the exhaustion of his mineral, not for the exhaustion of his manufactured product. Therefore, the deduction is a percentage of "gross income from mining" rather than gross income from manufacturing. When the only sales price is a sale of a manufactured product, the problem is how to calculate "gross income from mining." If the mineral were sold in crude form by other persons or corporations, there might be a "representative market price" for the mineral which could be used. Where there is no "representative market price," as in this case, the regulations 4 require the use of the proportionate profits method. This method apportions the gross income from the manufactured product between the mining phase and the manufacturing or nonmining phase in proportion that "mining costs" bear to "total costs." 5 The formula is expressed as follows:

By apportioning gross income on the basis of the ratio of mining costs to total costs, the formula assumes that each item of cost produces a pro rata share of the profits.

Under the proportionate profits method, one crucial determination is ascertaining which are mining costs, and which are not. As a general matter, that determination is controlled, in the case of cement, by Section 613(c)(4) (F). That section provides:

(4) Treatment processes considered as mining. The following treatment processes where applied by the mine owner or operator shall be considered as mining to the extent they are applied to the ore or mineral in respect of which he is entitled to a deduction for depletion under section 611:

(F) in the case of calcium carbonates and other minerals when used in making cement all processes (other than preheating of the kiln feed) applied prior to the introduction of the kiln feed into the kiln, but not including any subsequent process;

The statute provides that some treatment processes are considered part of mining. In the case of cement, the statute provides, and the parties agree, that mining includes all processes applied prior to the introduction of the kiln feed into the kiln, but does not include any subsequent process. This point at which the mining phase ceases and the manufacturing or nonmining phase begins is called the "cutoff" point. 6 In the first issue of the instant case, discussed in Part III, we are concerned with the proper treatment of certain costs incurred after the "cutoff" point.

The proportionate profits method begins with the sales price or gross income from the manufactured product (cement) and arrives at a constructive figure for the sales price of the mineral, namely, "gross income from mining." In this way the taxpayer is allowed a deduction based upon gross income attributable to his mining operations. It is apparent that the proportionate profits method includes within "gross income from mining" all mining costs and the pro rata profits attributable thereto, and, conversely, excludes from "gross income from mining" all nonmining costs and the pro rata profits attributable thereto.

In this opinion we sometimes refer to "gross income from mining" as taxpayer's depletable base, since taxpayer is entitled to a percentage depletion deduction based on "gross income from mining."

A. Facts and Posture of the Issues.

In this part of our opinion, we consider the proper treatment, in applying the proportionate profits formula, of the following items: (1) bag premium; (2) cost of the bags and cost of packing and loading the bags; (3) cost of loading bulk cement onto rail cars, barges, or trucks; and (4) cost of owning and operating the distribution terminals which taxpayer maintains for the purpose of having cement readily available for delivery in areas where taxpayer has no plant. 7

A higher price was charged by taxpayer for cement sold in bags as compared to cement sold in bulk. This additional amount is known in the industry as a "bag premium." The amount of the bag premium during each of the years in question was approximately 40cents to 60cents per barrel, or 10cents to 15cents per bag. In setting and charging the bag premium, taxpayer intended to recover the...

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