General Portland Cement Co. v. United States, Civ. A. No. 3-5212-F.

• Decision Date: 17 May 1977
• Docket Number: Civ. A. No. 3-5212-F.
• Citation: 438 F. Supp. 27
• Parties: GENERAL PORTLAND CEMENT COMPANY v. UNITED STATES of America.
• Court: U.S. District Court — Northern District of Texas

438 F. Supp. 27

GENERAL PORTLAND CEMENT COMPANY v. UNITED STATES of America.

Civ. A. No. 3-5212-F.

United States District Court, N. D. Texas, Dallas Division.

May 17, 1977.

Buford P. Berry, Dallas, Tex., for plaintiff.

Eldon B. Mahon, U. S. Atty. by Martha Joe Stroud, Asst. U. S. Atty., Eugene G. Sayre, Tax Div., Dept. of Justice, Dallas, Tex., William W. Guild, Atty.-in-Charge by Peter J. Grabicki, G. Tomas Rhodus, Attys., Tax Div., Dept. of Justice, Dallas, Tex., for defendant.

MEMORANDUM OF DECISION

I. NATURE OF CONTROVERSY

ROBERT W. PORTER, District Judge.

Plaintiff, General Portland Cement Company (the name of which has been changed to General Portland, Inc.), complains that the United States (hereinafter referred to as the IRS or Service) erroneously assessed and collected $2,178,046.42 for the taxable years beginning December 31, 1960, through and including December 31, 1968.¹ Plaintiff urges an increase in the amount it has been allowed to take as a depletion deduction arguing that specific costs and income are properly attributable to plaintiff's mining operation. Finding both jurisdiction and venue proper in this case, trial was held, without jury, beginning May 14, 1975. After full consideration of all facts, argument, briefs, and for the following reasons it is decided that:

1. The "bag premium" (increased price on the sale of bagged cement) is an increase in the sales price of cement sold and may not be set-off against "bag costs".

2. The cost of bags and the cost of packing and loading cement is a direct manufacturing expense;

3. The cost of owning and operating terminal facilities is a direct manufacturing expense;

4. The discount which was granted by General Portland to its customers is a cash discount and therefore does not reduce the price of the cement which was sold but rather is a financial expense which is allocable; and

5. The interest expense of borrowed funds can be netted with interest income and included in allocable administration overhead.

The conceptual question posed in this decision is whether this Court will characterize certain costs as direct mining costs, direct manufacturing costs, indirect expenses, or costs related neither to mining nor manufacturing. It will also be necessary to decide either to include or exclude certain income items from the total dollar amount of gross sales derived from cement. To analyze those questions the proper factual and legal framework must first be developed. Therefore I begin in Section II by outlining the method by which cement is manufactured and marketed as well as by describing the underlying economic condition of the cement industry generally and General Portland in particular. In Section III, I develop a legal framework for the proportionate profits method and analyze the actual dynamics of the arguments presented to the court. That is, I demonstrate the "moving force of" each argument in general terms using simple arithmetic computations as examples. Section IV presents a detailed analysis of each cost or item of income and an application of the correct rule of law to the specific issues in dispute. Finally, Section V contains a summary of the Court's conclusions as well as an order to prepare judgment.

II. BACKGROUND

A. The Making of Cement.

General Portland is an integrated mining and manufacturing company which produces cement and cement products. During the years at issue in this suit, Plaintiff mined limestone, clay and shale² and processed those raw materials into finished cement at nine locations in the United States. The plants were divided among five divisions, and the department leader at each division reported directly to each of his superiors at corporate headquarters.

The manufacture of cement begins with limestone, shale, or clay which is first mined at a quarry and then transported to a primary crusher which reduces the size of the ore. That crushed ore is stockpiled near the processing plant along with other necessary minerals which are either purchased or extracted from Plaintiff's quarries. Water is added and the minerals are further ground, creating a mixture which has the appearance of mud and is called "slurry." Slurry is then pumped into large slurry-blending, and storage tanks where it is agitated continually to keep the solids from settling and to keep the mixture homogeneous. From the slurry-blending tanks, the slurry is then pumped into a rotary kiln where it is heated. A series of chemical reactions take place as the slurry is transformed by the heat into which is termed a "cement clinker". The cement clinker is cooled and later the clinker, along with gypsum, is ground into finished cement which is transported to storage silos at the plant or at distribution terminals. There is no dispute between the parties with regard to the actual methods of manufacturing used by the Plaintiff.

B. The Marketing of Cement.

Plaintiff sells the cement which it produces either in bulk or in paper bags. Cement in bulk is loaded directly from a storage silo into a rail car, barge, or truck for shipment. Upon receiving an order for bagged cement, the finished cement is transported from the storage silo to a bagging machine. There is no chemical or practical difference between the cement loaded from the storage silo to a truck or a barge and that loaded into a bag. Plaintiff did not keep an inventory of packaged cement but rather filled bags only when actual orders were received. From ten to twenty percent of Plaintiff's gross sales were attributable to the sale of cement in bags during the years 1961 through 1968. A higher price was charged by Plaintiff for cement sold in bags as compared to cement sold in bulk; that additional price is termed a "bag premium" by the industry.

The amount of the bag premium during each of the years in question was approximately ten to fifteen cents per bag.³ It is Plaintiff's contention that it intended to recoup, if possible, the additional cost incurred in bagging cement and that the bag premium was not an increase in the price of cement. In support of that contention Plaintiff elicited testimony that its corporate headquarters, which set the amount of the bag premium, collected information from the division accounting departments concerning the cost of bags, and from the plant operations departments concerning the cost of packing and loading the bags, in order to determine the additional costs incurred in bagging the cement and by that process established the amount of the bag premium. It is further argued that the bag premium charged by the Plaintiff did not exceed the cost of the bags plus the additional costs incurred in packing and loading the cement in bags.

During each of the years in issue, Plaintiff offered a cash discount to its customers for prompt payment. The amount of the discount through November 1, 1961 was ten cents per barrel for white cement. From about November 1, 1961, and through December 31, 1968, the discount was twenty cents per barrel for gray cement and forty cents per barrel for white cement. The basic terms of the discount through January 1, 1964 were:

Discount if payment made within fifteen days from the date of invoice, full payment due within thirty days of invoice.

From January 1, 1964 through December 31, 1968 the basic terms of the discount were:

Discount allowed if payment made by the 10th of the month for shipment invoiced during the previous month, full payment due by the last day of the month following the month of shipment.

Similar cash discounts had been offered by the Plaintiff since at least 1948. Most other competing cement manufacturers also offered what they termed a "prompt payment discount" with terms similar to those offered by the Plaintiff. As the industry discount would rise or fall, Plaintiff would meet those changes.

Plaintiff advised all of its customers of the terms of its discount through trade quotations, specific work contracts, and sales invoices. The sales invoices which were transmitted to the customer for payment reflected the total invoice price, without reduction for the discount, and a separate statement contained the discount amount. Plaintiff did not charge its customers anything denominated interest on accounts paid beyond the date specified in the invoice. If the account remained unpaid for more than ninety days, the Plaintiff would generally attempt to obtain a promissory note from the customer in the amount owing on the account and bearing interest at four to five percent per annum.

Between 1961 and 1968, ninety to ninety-five percent of Plaintiff's customers took advantage of the discount offered to them. Approximately eighty to eighty-five percent of those who did not take advantage of the discount complied with Plaintiff's terms by transmitting the total price to Plaintiff after the expiration of the discount period. The remainder of the customers who did not earn the discount offered by Plaintiff attempted to take advantage of the discount without complying with the discount terms, by transmitting the next payment to the Plaintiff after expiration of the discount period. In those situations the Plaintiff, disallowed for the most part, the discount claimed by the customer and rebilled the customer.⁴

Since 1950, Plaintiff has allowed the division sales manager to determine whether a discount should be disallowed if the net payment was received within three days from the end of the discount period. The three day grace period was initiated in response to tardy postal service. On occasion the division sales manager disallowed, discounts taken by customers where the payment was received within the three day grace period and the customer was habitually late in payment. The division sales manager did not have the authority to allow a discount where the net payment was received more than three days after the end of the discount period. A discount taken after that period could be allowed only upon...