RLC Indus. Co. & Subsidiaries v. Comm'r of Internal Revenue
| Decision Date | 22 April 1992 |
| Docket Number | Docket No. 33335-87. |
| Citation | 98 T.C. No. 33,98 T.C. 457 |
| Parties | RLC INDUSTRIES CO. AND SUBSIDIARIES, SUCCESSOR TO ROSEBURG LUMBER CO. AND SUBSIDIARIES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
P, a large timber user, combined its Oregon and California timber into a single block for purposes of computing its depletion under secs. 611 and 631, I.R.C. R determined and contends that: (1) P's approach is not permissible under the regulations; (2) even if P's approach is permissible, it is not the method which most clearly reflects income; and (3) in any event sec. 1.611-3(d)(5), Income Tax Regs., provides R with discretional authority to change timber accounts even where they may be kept under permissible methods. P contends that: (1) its approach is permissible under the regulations; (2) its approach clearly reflects income and meets GAAP, and its accountant's approval; and (3) R abused her discretion. HELD: The pooling of P's Oregon and California timber was within the ambit of the regulations. (The standards for deciding whether there has been compliance with sec. 1.611.3(d)(1), Income Tax Regs., are established and discussed.) HELD FURTHER: P's method for depletion resulted in a clear reflection of income and R does not have absolute or unconditional authority to change a taxpayer's method for computing timber depletion. HELD FURTHER: R abused her discretion in attempting to change P's pooling approach for timber depletion. William H. Bradley, Randolph W. Thrower, and John H.
Fleming, for petitioner.
Robert F. Geraghty, Alan Summers, and Randall E. Heath, for respondent.
Respondent determined deficiencies in petitioner's Federal income tax as follows:
+---------------------+
¦TYE ¦Deficiency ¦
+-------+-------------¦
¦3/31/78¦$2,171,826 ¦
+-------+-------------¦
¦3/31/79¦972,853 ¦
+-------+-------------¦
¦3/31/80¦2,006,426 ¦
+-------+-------------¦
¦3/31/82¦65,254 ¦
+-------+-------------¦
¦3/31/83¦3,444,367 ¦
+---------------------+
The sole unagreed issue in this case is whether petitioner properly computed its timber depletion allowance during fiscal years ending March 31, 1980, 1982, and 1983 by combining all its merchantable 1 fee timber into one composite depletion account. Respondent disallowed this combination and recomputed petitioner's depletion for these years using two depletion accounts separately reflecting petitioner's merchantable timber holdings in Oregon and California.
Some of the facts have been stipulated and the stipulation of facts and accompanying exhibits are incorporated by this reference.
Petitioner RLC Industries Co. is a corporation organized under the laws of the State of Oregon with its principal offices located in Dillard, Oregon. Petitioner and its subsidiaries are the successors in interest to Roseburg Lumber Co. and Subsidiaries. 2 Roseburg and its subsidiaries timely filed consolidated Federal income tax returns for its fiscal years ending March 31, 1978, through March 31, 1983. In July 1987, respondent issued a statutory notice determining deficiencies for fiscal years ending March 31, 1978, 1979, 3 1980, 1982, and 1983. Petitioner filed a timely petition contesting these deficiencies in October 1987.
Petitioner is an integrated forest products company. At all relevant times, Roseburg has been a closely held, family-owned business. Since its beginning, the company and its operations have been controlled by its founder and principal shareholder, Mr. Kenneth Ford. Mr. Ford, who at the time of trial was over 80, continued to serve as chairman of the board and to take a direct interest in all aspects of the company's operations. His son, Allyn Ford, has been involved with the company all his life, and at the time of trial served as vice president of timber and raw material resources.
The company was established in 1936 and began as a small sawmill, manufacturing dimension lumber in the community of Roseburg, Oregon. By 1979, Roseburg had grown substantially and had expanded its product lines to include the manufacture of lumber, particleboard, sheathing, wood chips, and plywood. At the time of trial, petitioner was the largest producer of sanded plywood in the United States. Plywood is made, generally, by “peeling” logs into a thin veneer. Veneer is an intermediate product which is “clipped” into sheets. The sheets are sorted by dimension, dried, and glued together in three-, five-, or seven-ply products.
For Roseburg's most important product, sanded plywood, the “faces” or exterior plies have been made from high-grade, old-growth douglas fir, found primarily in southern Oregon. However, because of declining douglas fir supply, Roseburg developed a method of using “white wood” as the interior core of its plywood product. White wood includes white fir, pine, or hemlock, which are generally low-grade wood species which many manufacturers did not like to use. Roseburg's use of white woods as the core of sanded plywood extended its limited supply of douglas fir and enabled it to make optimal use of all its timber species. Its effective use of these species also afforded the corporation greater geographical flexibility.
As of 1979, all of Roseburg's manufacturing facilities were located in southwest Oregon with its main complex in Dillard, Oregon. As of 1989, the Oregon facilities consisted of six plywood plants, three particleboard plants, two sawmills, two wood chip plants, and one veneer plant. Petitioner's Riddle plywood plant and its Dillard particleboard plant are some of the largest in the world. Petitioner's Oregon operations are an interrelated and highly integrated complex of manufacturing facilities which enabled petitioner to make optimal use of all its wood species, grades, and manufacturing by-products.
In the first 10 years of its existence, Roseburg owned no fee timberlands. Instead, it relied on purchases from small privately held tracts physically close to its sawmill operation for its principal source of wood. However, from 1948 through 1977, Roseburg acquired several parcels of fee timberlands located in southwest Oregon. As of September 1979, Roseburg's Oregon fee timber totaled 1,410,100 MBF 4 (long log scale), 5 had an average cost basis of $7.74/MBF, and a total cost basis of $10,916,000.
The company's policy was to regard its company-owned or fee timber (which was generally mature and ready to harvest) as an “insurance policy” to be held until either economic conditions or forestry conditions dictated harvest of its fee timber. Because petitioner did not generally rely on its own supply of fee timber, its wood supply was derived from cutting contracts on Government or privately owned Douglas County timberland in southwest Oregon. Petitioner was largely dependent upon the Federal Government as its wood supplier. Throughout the 1960s and 1970s, 80-85 percent of Roseburg's timber supply came, directly and indirectly, from Federal timber contracts. Petitioner's Federal timber was purchased pursuant to long-term (3-7 years) cutting contracts from the United States Forest Service (USFS) and the Bureau of Land Management.
Timber from Federal contracts was initially projected to remain stable during the 1970s. However, Federal legislation enacted during this period 6 began to decrease the availability of Federal timber. Federal set-aside programs enacted in the late 1970s also limited the ability of large companies to acquire increased shares of Government contract timber in some geographical areas.
Although petitioner was largely dependent on Federal timber, it also faced a declining supply of private timber in the immediate areas around its mills. By the mid-1970s, the larger timberland owners in the locality had liquidated most of the available stands. In 1976, the so-called Beuter Report entitled, “Timber for Oregon's Tomorrow”, was published. That report predicted decreased wood availability from private lands and future timber shortages throughout most of Oregon in the late 1990s.
In the late 1970s, timber prices escalated dramatically due to diminishing timber supply, inflation, optimistic reports of growing wood demand, and increased housing starts. Between 1970 and 1979, the average statistical high bid on long-term USFS timber cutting contracts for douglas fir in Douglas County rose from approximately $49/MBF to $432/MBF. The limited supply and increased demand created tremendous competition for timber purchases and resulted in price bidding sprees. In order to stay competitive and to retain access to Federal timber, petitioner continued to bid on Government timber sales. Roseburg also dramatically expanded its areas of bidding further north, east, and south into northern California. It also began looking for new sources of fee timberland supply.
Roseburg was unable, for geographical and competitive reasons, to expand its Oregon fee holdings. 7 In the process of expanding its bidding horizons, petitioner discovered that it could avoid a lot of industry competition by purchasing California douglas fir, white fir, pine, and cedar. During 1977- 79, Roseburg purchased cut logs from major and small suppliers in northern California for use in its Oregon mills. Although these purchases represented a very small percentage of Roseburg's average annual consumption, the company discovered an economic advantage in the use of these lower grade species. Compared to the same species in Oregon, California white wood was of superior quality for use as inner plies of plywood because of the smaller knot size and the relative lack of “shake”. 8 California white fir also produced a higher percentage of “C” grade 9 veneer (compared to “D” grade) than did Oregon white wood.
In 1978, Roseburg investigated the purchase of a veneer mill in Yreka, California, to process undried veneer...
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