United States v. Henderson Clay Products

• Decision Date: 30 December 1963
• Docket Number: No. 19471.,19471.
• Citation: 324 F.2d 7
• Parties: UNITED STATES of America, Appellant, v. HENDERSON CLAY PRODUCTS, Appellee.
• Court: U.S. Court of Appeals — Fifth Circuit

324 F.2d 7 (1963)

UNITED STATES of America, Appellant, v. HENDERSON CLAY PRODUCTS, Appellee.

No. 19471.

United States Court of Appeals Fifth Circuit.

October 25, 1963.

Rehearing Denied December 30, 1963.

Louis F. Oberdorfer, Asst. Atty. Gen., Lee A. Jackson, Atty., Dept of Justice, Washington, D. C., William Wayne Justice, U. S. Atty., Tyler, Tex., Melva M. Graney, Robert L. Waters, Attys., Dept. of Justice, Washington, D. C., Lloyd W. Perkins, Asst. U. S. Atty., for appellant.

Benjamin L. Bird, Fort Worth, Tex., Chas. W. Shaw, Henderson, Tex., Robert B. Wallace, Corpus Christi, Tex., for appellee, Weeks, Bird, Cannon & Appleman, Fort Worth, Tex., Waldrop, Shaw & Colley, Henderson, Tex., of counsel.

Before TUTTLE, Chief Judge, and WISDOM and GEWIN, Circuit Judges.

WISDOM, Circuit Judge.

The problem this tax case presents is one of defining "gross income from mining" in determining the depletion allowance for an integrated miner-manufacturer of ball clay processed into bricks. The chief difficulty arises from the fact that although the first commercially marketable product of non-integrated clay miners is shredded ball clay having a market price of $10.50 a ton, the taxpayer sold its finished brick for only $8.75 a ton.

Section 23(m) of the Internal Revenue Code of 1939, 26 U.S.C.A. § 23(m), established a deduction of a "reasonable allowance for depletion" of mineral resources, such allowance "to be made under rules and regulations to be prescribed by the Commissioner". Section 114(b) (4) (A) (iii) of the Internal Revenue Code of 1939 provides for a depletion allowance for clay of 15 per cent "of the gross income from the property", such allowance not to exceed 50 per cent of the net income of the taxpayer from the property. Subsection (B) defines "gross income from the property" as "gross income from mining". Mining includes "not merely the extraction" but also "the ordinary treatment processes and minimum transportation normally applied * * * to obtain the commercially marketable mineral product". Gross income is further defined in Section 39.23(m)-1(e) (3) of Treasury Regulations 118. This regulation provides that when the mined product is processed or transported beyond those minima described in Section 114 (b) (4) (B), constructive gross income from the product is established by one of two methods. (1) The taxpayer takes the "representative market or field price (as of the date of sale) of a mineral product of like kind or grade as beneficiated by the ordinary treatment processes actually applied, before transportation of such product", and multiplies that price by the tonnage of minerals actually mined. (2) Or, if there is no such representative price for the depletable mineral product, the proportionate profits method is used to determine a constructive income from the property. This is the proportion of the sales price of the final product equalling the percentage which the costs of mining and processing the mineral bear to the total cost of producing the finished goods.

Henderson Clay Products, the taxpayer, is an integrated manufacturer: its production process includes all functions from the extraction of ball clay mined from its own pits near Henderson, Texas, to the conversion of the clay into finished bricks which the company sells throughout the country. The clay is strip-mined, by draglines or shovels, and hauled to the plant where it is crushed and shredded to manageable size, after which it is blended and ground to a uniform particle size. It is then transported to a pug mill where, mixed with water, the clay is formed into the shape of bricks, dried, burned in kilns, and shipped or stored for later shipment. None of it is sold in raw or semi-processed form. The per ton price for Henderson's finished brick averaged approximately $8.75 over this four year period.

For the fiscal years 1951-54, the taxpayer used the gross income from its finished brick as the basis for its depletion allowance.¹ The Commissioner challenged these returns and assessed deficiencies based on the proportionate profits method for determining percentage depletion. Henderson paid the deficiencies and filed suit for refund, contending that since brick was its first commercially marketable product, its gross income from mining was its gross income from the brick. See, for example, Cherokee Brick & Tile Co. v. United States, 5 Cir.1955, 218 F.2d 424; United States v. Merry Brothers Brick & Tile Co., 5 Cir.1957, 242 F.2d 708, cert. den'd 1957, 355 U.S. 824, 78 S.Ct. 31, 2 L.Ed. 2d 38.

During one of five continuances of the action,² the Supreme Court decided United States v. Cannelton Sewer Pipe Co., 1960, 364 U.S. 76, 80 S.Ct. 1581, 4 L.Ed.2d 1581. Cannelton holds that "ordinary treatment processes" are to be considered those applied by the ordinary non-integrated miner.³ The depletion allowance, therefore, should be based on the value of the mineral at the point where the non-integrated miner disposes of it and not on the value of the finished product; the integrated manufacturer "but sells to himself the crude mineral that he mines". As succinctly stated in the recent case of Riddell v. Monolith Cement Co., 1962, 371 U.S. 537, 538, 83 S.Ct. 378, 9 L.Ed.2d 492, reversing 9 Cir., 301 F.2d 488, Cannelton held that "the statutory percentage depletion allowance should be cut off at the point where the mineral first became suitable for industrial use or consumption * * * namely, `where the ordinary miner shipped the product of his mine.'"

Promptly after Cannelton was decided, the taxpayer amended its complaint. The amended complaint alleged, and the district court found, that there is a national market for shredded ball clay of like kind and grade to Henderson's clay at $10.50 a ton. Accordingly, the court held that the taxpayer was entitled to use the first method of constructing gross income, as set forth in Section 39.23(m)-1(e) (3) of Treasury Regulation 118. 199 F.Supp. 304. We reverse.

I.

The disparity between the $8.75 price for Henderson's brick and the representative price of $10.50 for shredded ball clay, strange as it may seem, is explainable. There is substantial evidence in the record that in the relatively small national market for ceramic clay, as contrasted with the market for brick, the costs of advertising, management, and research, necessary to sell the clay, offset the higher price per ton it commands. One of the Government's own witnesses, the president of a clay mining company, and a forty-year veteran of the business, testified that the price obtainable for clay bears no necessary relation to its quality; rather, the price is determined by "management, salesmanship, promotion, and usability of the material and the dependability of the producer." Henderson's secretary-treasurer and the general manager testified that Henderson did not attempt to sell clay because, being a young company, it was not prepared to install the extra equipment, processing, research, and engineering departments required in order to sell ball clay. It is not an unfair inference that Henderson found it more profitable and easier to sell brick for a smaller gross income per ton than to incur the expenses and increase the business complications involved in merchandising the clay on a nation-wide scale against experienced competitors.

Over 90 per cent of ball clay sold in the United States is mined in four counties in Kentucky and Tennessee. Henderson's witnesses testified that the taxpayer's clay had properties substantially similar to the Kentucky-Tennessee clays, that it was the equivalent in range and grade of qualities to the average clay from that area, and that it was extracted by mining techniques similar to those employed by the Kentucky-Tennessee miners. The Government's expert witnesses controverted some of this testimony. However, "all conflict between experts as to commercial identity of the product has repeatedly been held peculiarly a matter for the determination of the trier of fact." Riddell v. California Portland Cement Co., 9 Cir. 1962, 297 F.2d 345, 351. See also Sartor v. Arkansas Natural Gas Corp., 1944, 321 U.S. 620, 621, 64 S.Ct. 724, 726, 88 L.Ed. 967.

Recognizing the difficulty in attacking on appeal the district court's factual determination, the Government challenges the finding on the ground that the court erred in assuming or finding that all ball clays are of "like kind and grade"; that since Henderson's shredded clay was not mined nearly as selectively as the Kentucky-Tennessee clay, it could not possibly be of like kind and grade to the clay mined by the Kentucky-Tennessee producers.

We are unable to accept this argument. It is premised on too narrow a construction of the phrase, "like kind and grade." The regulation speaks of "like" rather than "the same" or "identical".

In Alabama By-Products Corp. v. Patterson, 5 Cir. 1958, 258 F.2d 892, cert. den'd 1958, 358 U.S. 930, 79 S.Ct. 318, 3 L.Ed.2d 303, the taxpayer, an integrated miner-manufacturer who would have gained a higher depletion allowance by using the proportionate profits method of determining basis rather than the representative field price, made an argument very similar to that advanced by the Government here. The company contended,

"that the phrase `mineral product of like kind and grade\' as used in Section 39.23(m)-1(e) (3) refers to mineral products with the same inherent attributes and characteristics as the depletable mineral in question. The taxpayer points to the many physical and chemical properties that distinguish kinds of coking coals. Coking coals differ as to volatile matter, ash content, carbon pickup, sulphur content, porosity, and phosphorous content. * * * The taxpayer argues therefore that none of the coking coal sold was of a `like kind and grade\' to the taxpayer\'s." 258 F.2d at 896-897.

In rejecting this argument, we held that

"`like kind\' is a broad phrase contemplating the distinction between

...