Petition — Commissioner v. Portland Cement Co.

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Supreme Court, U,

FILED

79-1907 } JUN 8 1980

No.

EMICHRET-RODAK, JR. CLERN

oe ee eee

Iu the Supreme Court of the United States

OCTOBER TERM, 1979

COMMISSIONER OF INTERNAL REVENUE, PETITIONER

Vv.

PORTLAND CEMENT COMPANY OF UTAH

PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS

FOR THE TENTH CIRCUIT

WADE H. McCREE, JR.

Solicitor General

M. CARR FERGUSON

Assistant Attorney General

STUART A. SMITH

Assistant to the Solicitor General

JONATHAN S. COHEN

DAVID ENGLISH CARMACK

Attorneys

Department of Justice

Washington, D.C. 20530

Page

Opinions below _____. ana 1

NU, ool a ee 1

Ceeeetions SENRNeNS 5, 2

Statues and regulations involved ______________. 2

Statement HA REEY Str MM SMES 3

Reasons for granting the petition __________.. 7

Cee: oe enue = 21

Appendix A ‘iccicnapadbcagae caaaa la

PING TR sc oschcee~ ceapuconeepioopntn scanned .'' ae

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Appendix D _ 6 Selene siadealioemnideaataigedintees 18a

CITATIONS

Cases:

Arvonia-Buckingham Slate Co. v. United

States, 426 F.2d 406 9, 13,17

Commissioner v. South Texas Co., 333

UA. We 2 Gee eee 16

Douglas v. Commissioner, 322 U.S. 275 _ 16

General Portland Cement Co. v. United

States, 438 F. Supp. 27, appeal pend-

ing, No. 77-2881 (5th Cir.) .................. 15, 18

Golsen v. Commissioner, 54 T.C. 742,

aff’d on other issues, 445 F.2d 985, cert.

deed, 66 US. 30 5, 6

Mississippi Valley Portland Cement Co. v.

United States, 347 F. Supp. 240 _____. 18

Portland Cement Co. of Utah v. United

States, 412 F.2d 894 SPARE Deere Sz et 6

Cases—Continued Page

Southwestern Portland Cement Co. v.

United States, 485 F.2d 504 17

Standard Lime & Cement Co. v. United

kk eee 9,18

United States v. California Portland Ce-

ment Co., 413 F.2d 161 ................ 9, 10, 18, 14,

17, 20, 14a

United States v. Cannelton Sewer Pipe

Co., 364 U.S. 76 __ Le COINS WN AID 11, 16

United States v. Ideal Basic Industries,

Inc., 404 F.2d 122, cert. denied, 395

U.S. 936, rehearing denied, 396 U.S.

ee 6, 7, 8, 9, 10, 14, 20, 21, 15a

United States v. Portland Cement Co. of

Utah, 378 F.2d 91, cert. denied, 389

i ceneabindeneceninte 13

Whitehall Cement Manufacturing Co. v.

United States, 369 F.2d 468 ................ 8, 9, 18,

14, 15,17

Statutes and regulations:

Internal Revenue Code of 1954 (26

U.S.C.) :

Ls eee <ul 2

Section 611(a) -................._........11, 16, 18a

Section 6138(a) —.................._.11, 18a, 19a

Section 613(b) __......................11, 18a, 19a

Section 613(b)(7) 11, 19a, 20a

Section 613(c)(1) —.....-..------.. 2

Section 1.613-4(g)(3) 18, 42a-43a

Section 1.613-4(g) (4) _........18, 42a-43a

Treasury Regulations (26 C.F.R.):

Section 1.613-3 __ So 3

Section 1.613-3(d) (1) (iv) ............... 14, 25a

Ill

Statutes and regulations—Continued Page

Sr i 3

Section 1.613-4(d) 12, 32a-39a

Section 1.613-4(d) (3) (i) 0. 18, 33a

Section 1.613-4(d) (8) (iii) 18, 38a-35a

Section 1.613-4(d) (3) (iv) — 19, 35a-43a

Section 1.613-4(d) (4) 2... 4

Section 1.613-4(d) (4) (i) 13, 35a-36a

Section 1.613-4(d) (4) (ii) —... 13, 36a-37a

Section 1.613-4(d) (4) (iv) 6

Treasury Regulations 103 (19389 Code),

Section 19.28(m)-1(f) _..- 4

Treasury Regulations 111 (1939 Code),

Section S39.28(m)-1 4

Treasury Regulations 118 (1939 Code),

Section 39.23(m)-l(e) 0. 4, 22a-24a

UN RE hc eh 3

Section 1.613-5(c) (4) (ii) —.......19, 35a-48a

“Miscellaneous:

Paton and Littleton, An Introduction

to Corporate Accounting Standards

(American Accounting Association

I chic peaccccohapia teen mae ek 13

T.D. 6965, 1968-2 Cum. Bull. 265 15

T.D. 7170, 1972-1 Cum. Bull. 178 an 15

Iu the Supreme Court of the United States

OCTOBER TERM, 1979

No.

COMMISSIONER OF INTERNAL REVENUE, PETITIONER

Vv.

PORTLAND CEMENT COMPANY OF UTAH

PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS

FOR THE TENTH CIRCUIT

The Solicitor General, on behalf of the Commis-

sioner of Internal Revenue, petitions for a writ of

certiorari to review the judgment of the United

States Court of Appeals for the Tenth Circuit in

this case.

OPINIONS BELOW

The memorandum findings of fact and opinion of

the Tax Court (App. A, infra, la-lla) is unofficially

reported at 36 T.C.M. 578. The opinion of the court

of appeals (App. B, infra, 12a-i6a) is reported at

614 F.2d 724.

JURISDICTION

The judgment of the court of appeals was entered

on February 5, 1980 (App. C, infra, 17a). By order

dated April 24, 1980, Mr. Justice White extended

the time for filing a petition for a writ of certio-

(1)

rari to and including June 4, 1980. The juris-

diction of this Court is invoked under 28 U.S.C.

1254(1).

QUESTIONS PRESENTED

Where the depletable “gross income from mining”

under Section 613(c)(1) of the Internal Revenue

Code of 1954 of an integrated miner-manufacturer

of cement must be determined under the “propor-

tionate profits” method, 7.e., an allocation of the re-

ceipts from the sale of its manufactured product to

the mining phase of its operation in the ratio that

its mining costs bear to its total (mining plus non-

mining) costs:

1. Whether, in determining the amount of income

to be allocated in accordance with the costs ratio, the

income is to be computed on the assumption that only

cement sold in bulk is respondent’s first marketable

product, as the decision below held, or that both bulk

and bagged cement constitute respondent’s first mar-

ketable product, in accordance with the governing

Treasury Regulations.

2. Whether, in determining the ratio of mining

to total costs, post-manufacturing costs of bags, bag-

ging, storage, distribution, and sales should be in-

cluded in the proportionate profits computation as

nonmining costs, in accordance with the governing

Treasury Regulations.

STATUTES AND REGULATIONS INVOLVED

The applicable provisions of Sections 611 and 613

of the Internal Revenue Code of 1954 (26 U.S.C.),

Treasury Regulations 118 (1989 Code), Section

39.23 (m), and Treasury Regulations, Sections 1.613-3,

1.613-4, 1.613-5 (26 C.F.R.), are set forth at App. D,

infra, 18a-48a.

STATEMENT

1. Respondent is a Utah corporation which is an

integrated miner-manufacturer of Portland cement.

For many years, it has engaged in the quarrying of

an argillaceous rock, known as cement rock, and the

processing of that rock into finished Portland cement

(App. A, infra, 2a).

The mining phase of respondent’s operations be-

gins with the blasting of the cement rock from the

face of the mountainous quarry owned by it. The

loose rock is then fed through machinery which re-

duces the material to a size of less than one square

inch. After transportation to a processing plant, the

material is ground to a high degree of fineness. Dur-

ing the grinding process, water is added to the powder

and a very fine mud, known as “slurry,” is formed.

The slurry is stored in tanks where it is continuously

agitated to maintain a uniform texture. Respondent

conducts frequent chemical analyses of the slurry to

ensure that it is of a proper composition for making

Portland cement (App. A, infra, 2a-3a).

During the manufacturing phase of respondent’s

operations, the liquid slurry is fed into rotary kilns

and fired. The heat of the kiln expels moisture

from the material and converts carbonates to oxides.

As the material is heated to the point of fusion, a

hard glass-like substance, known as a clinker, is

formed. The clinker is thereafter cooled and ground

with purchased gypsum to produce finished cement.

After the final grinding, respondent places its fin-

ished cement in storage silos to await sales to cus-

tomers (App. A, infra, 3a-4a).

During the taxable years at issue, respondent sold

its finished cement in two ways, either in bulk or in

bags. Most of respondent’s output was sold in bulk

in tank cars, which were loaded directly from the

storage silos. A small portion of the output was run

from the storage silo into a bin above a bagging

machine where it was sealed in paper bags in which

it was thereafter sold (App. A, infra, 4a).

2. On its federal income tax returns for the taxable

years ended March 31, 1970-1972, respondent com-

puted its “gross income from mining” in accordance

with the proportionate profits method set forth in

Treasury Regulations, Section 1.618-4(d)(4) (26

C.F.R.) (App. D, infra, 35a-89a). This method has

been prescribed by successive Treasury Regulations

since 1940.’ It allocates the sales price of the inte-

grated miner-manufacturer’s first marketable product

between the mining and nonmining phases of its

operations in the same ratio as the costs of its min-

ing process bear to its total costs.

On its tax returns for the years in question, re-

spondent took the position that bulk cement, and not

1 See Treasury Regulations 103 (1989 Code), Section 19.23

(m)-1(f); Treasury Regulations 111 (1989 Code), Section

29.23(m)-1; Treasury Regulations 118 (1939 Code), Section

89.23(m)-1(e) (3), App. D, infra, 22a-24a,

bulk and bagged cement, constituted its first market-

able product. It also excluded from the proportionate

profits method formula the costs it incurred for stor-

age, distribution and sales. Respondent reported a

greater amount of “gross income from mining” (and

thereby claimed a greater depletion base) by applying

the proportionate profits computation to the gross

sales price of its bulk cement and by excluding the

costs of bags, bagging, storage, distribution, and sales

from the total costs element of the formula (App. A,

infra, 6a).

3. On audit, the Commissioner of Internal Reve-

nue determined deficiencies in respondent’s tax lia-

bilities on the grounds that: (1) bulk and bagged

cement constituted respondent’s first marketable

product, and (2) the costs of bags, bagging, stor-

age, distribution and sales were includable in the

“total costs” element in the formula. The Commis-

sioner’s computation yielded a reduced amount of

“gross income from mining” and a correspondingly

smaller depletion base (App. A, infra, la-2a, 6a).

Respondent thereafter brought this suit in the

Tax Court for redetermination of the deficiencies.

The Tax Court upheld respondent’s computation and

correspondingly larger depletion deduction. Invoking

the Golsen rule,’ pursuant to which the Tax Court

follows the law of the circuit to which a case would

be appealed, the Tax Court ruled that it was bound

2 See Golsen v. Commissioner, 54 T.C. 742 (1970), aff’d on

other issues, 445 F.2d 985 (10th Cir.), cert. denied, 404 U.S.

940 (1971).

by United States v. Ideal Basic Industries, Inc., 404

F.2d 122 (10th Cir. 1968), cert. denied, 395 U.S. 936

(1969) (Black and Harlan, JJ., dissenting; White

and Marshall, JJ., not participating), rehearing de-

nied, 396 U.S. 975 (1969) ; and Portland Cement Co.

of Utah v. United States, 412 F.2d 894 (10th Cir.

1969). In so holding, the Tax Court rejected the

Commissioner’s argument that subsequent changes in

the Treasury Regulations explicitly classifying the

costs of bags, bagging, storage, distribution, and

sales as nonmining costs made the Golsen rule inap-

plicable because the premises underlying the Tenth

Circuit’s earlier decisions were no longer valid (App.

A, infra, 8a-1la).

The court of appeals affirmed (App. B, infra, 12a-

17a), noting that “[w]e can add little, if anything, to

the analysis made by the Tax Court’’ (App. B, infra,

13a-14a). In so ruling, it considered dispositive its

earlier decision in Jdeal Basic Industries, that “ ‘bulk

cement’ is marketable as such, and under the Regula-

tions it is the ‘first marketable product.’ The bagged

cement is the next stage, and it is, as the Tax Court

indicated, the second marketable product” (App. B,

infra, 14a-15a).

Adhering to the Ideal Basic Industries rationale,

the court of appeals also rejected the Commissioner’s

argument that the cement in the bags is the same

product as the cement in the bulk silos and his

reliance upon Treasury Regulations, Section 1.613-

4(d) (4) (iv) (App. D, infra, 37a-38a). That Regu-

lation explicitly provides that “bulk and packaged

products are considered to be essentially the same

product.” As the court saw the matter, “[i]t is

obvious that both are ‘cement,’ but it is equally

apparent that it is ‘first marketable’ as bulk ce-

ment, not as bagged cement” (App. B, infra, 15a).

The court of appeals further agreed with the Tax

Court that the changes in the Regulations subsequent

to the Ideal Basic Industries decision were not sig-

nificant because they did not alter the definition of

“first marketable product” (App. B, infra, 15a).

The court of appeals also affirmed the Tax Court’s

exclusive of respondent’s bags, bagging, storage, dis-

tribution and sales costs from the “total costs” ele-

ment in the proportionate profits formula. In support

of this aspect of its holding, it adhered to its prior

ruling in Ideal Basic Industries that “the costs of

bagging and of bags were not mining costs, and

should be excluded under an application of the pro-

portionate costs doctrine” (App. B, infra, 15a; em-

phasis in original). In its view, “[t]hese costs thus

had no part there in the determination of the income

from the first marketable product. They have no part

here when Ideal Basic is applied” (ibid.).

REASONS FOR GRANTING THE PETITION

The rulings below are variously in conflict with the

decisions of the Courts of Appeals for the Third,

Fourth and Ninth Circuits and the Court of Claims.

The result is confusion and uncertainty in an area of

tax law that affects, in the first instance, the numer-

ous members of the integrated Portland cement in-

dustry who are located throughout the country. Po-

tentially affected are all integrated miner-manufac-

turer industries to the extent that the proportionate

profits method is necessarily applied in computing

the depletion allowances of their members. This

Court should resolve the conflict and establish a na-

tional rule so that the tax liabilities of integrated

miner-manufacturers can be determined in a uniform

manner.

1. In seeking review with respect to these ques-

tions, we recognize that the Court denied certiorari

11 years ago in a previous case decided by the court

below, United States v. Ideal Basic Industries, Inc.,

404 F.2d 122 (10th Cir. 1968), cert. denied, 395 U.S.

936 (1969) (Black and Harlan, JJ., dissenting, White

and Marshall, JJ., not participating), rehearing de-

nied, 396 U.S. 975 (1969); and that the court of

appeals upheld respondent’s position on the authority

of its earlier ruling in that case. If there were no

developments since this Court’s prior consideration

of the matter, we would be reluctant to petition for

certiorari a second time. The circumstances, how-

ever, have sufficiently changed to call for review by

this Court of what has now apparently become a

persistent refusal by the Tenth Circuit to accept the

fundamental premises underlying the proportionate

profits method.

(a) At the time the Court declined review in Ideal

Basic Industries, there was an unacknowledged con-

flict between: (1) the court below and Whitehall

Cement Manufacturing Co. v. United States, 369

F.2d 468 (3d Cir. 1966), with respect to the inclu-

sion of bagged cement in gross sales of the first

marketable product; and (2) the court below, on the

one hand, and Whitehall Cement and Standard Lime

& Cement Co. v. United States, 329 F.2d 939 (Ct.

Cl. 1964), on the other hand, with respect to the in-

clusion of post-manufacturing costs in the propor-

tionate profits computation.

However, since the denial of certiorari in Ideal

Basic Industries, two courts of appeals have ex-

plicitly rejected the Tenth Circuit’s approach. Thus,

in United States v. California Portland Cement Co.,

413 F.2d 161, 167-172 (1969), the Ninth Circuit held

that the costs of bags and bagging cement, and the

profits attributable to sale of bagged cement, must be

included in the proportionate profits method and that

such costs are allocable to the nonmining part of the

taxpayer’s operations.* The court also held that sell-

ing expenses must be included in the proportionate

profits computation. Moreover, in Arvonia-Buck-

ingham Slate Co. v. United States, 426 F.2d 484, 486-

487 (1970), che Fourth Circuit held that selling and

advertising expenses of an integrated miner-manu-

facturer must be included in the proportionate

profits computation.

There is now a square conflict of decisions on both

questions that has been explicitly acknowledged by the

3 The Ninth Circuit’s decision in California Portland Ce-

ment Co. was issued on June 4, 1969, two days after this

Court denied certiorari in Jdeal Basic Industries. Although

we called the attention of the Court to that decision in a

~xetition for rehearing in Jdeal Basic Industries, the Court

denied rehearing (396 U.S. 975 (1969)) (White and Marshall,

JJ., not participating).

Ninth and Fourth Circuits. Indeed, even the court

below conceded as much—albeit reluctantly—observ-

ing that “[t]he Ninth Circuit has apparently reached

a different result—at least as to non-mining costs—

in United States v. Calif. Portland Cement Co., 413

F.2d 161 (9th Cir.)” (App. B, infra, 14a). As long

as the court below adheres to its lone position, the

proportionate profits method, as established by the

Treasury Regulations and approved by the other fed-

eral courts, will not be correctly applied in the Tenth

Circuit. Thus, an integrated producer having a tax

home there may have his constructive mining income

and his depletion deduction improperly augmented

and thereby enjoy a competitive advantage over

similarly-situated taxpayers located outside the Tenth

Circuit. Events during the past decade therefore

demonstrate that the conflict will persist absent the

establishment of a national rule by this Court.

(b) Moreover, since the Court’s denial of cer-

tiorari in Jdeal Basic Industries, the administrative

importance of the questions presented has substan-

tially increased. In our petition in that case (No.

1279, October Term 1968), we stated (page 17) that

there were 22 similar cases presenting proportionate

profits issues then being litigated involving more

than $6 million in taxes. We are now advised by

the Internal Revenue Service that there are currently

24 proportionate profits cases presently pending

either in the courts or administratively with ap-

proximately $26 million at stake. The problem thus

continues to affect a substantial number of tax-

payers with respect to which there has been more

than a four-fold increase in the amount of reve-

nue at issue. Since it will be impossible for the

Treasury to administer the statute in an even-handed

manner until the conflict is resolved, this Court

should now settle the confusion and uncertainty that

affects both the government and industry alike with

respect to these important questions.

2. Section 611(a) of the Internal Revenue Code

of 1954 (App. D, infra, 18a) authorizes a “reason-

able allowance for depletion” of natural deposits “in

all cases to be made under regulations prescribed by

the Secretary or his delegate.” In the case of hard

minerals, the allowance is a specified percentage of

“gross income from mining.” Sections 618(a) and

(b) of the 1954 Code (App. D, infra, 18a-19a). The

rate for calcium carbonate rock, from which cement

is made, was 15% for respondent’s taxable year

ended March 31, 1970, and 14% for its taxable

years ended March 31, 1971 and 1972. Section 613

(b) (7) of the 1954 Code (App. D, infra, 19a-20a).

If a miner does not conduct manufacturing opera-

tions, 7.e., if he does not “destroy the physical or

chemical identity of the minerals or permit them to

be transformed into new products” (United States v.

Cannelton Sewer Pipe Co., 364 U.S. 76, 86 (1960) ),

his “gross income from mining” is usually his actual

“gross receipts from the sales of the raw material.

In the case of an integrated producer—one who does

not sell the raw material he mines, but uses it in his

own manufacturing operations—“gross income from

mining” is the producer’s constructive income from

the raw mineral product of his mining operations

(ibid.).

The governing Treasury Regulations (Section

1.613-4(c) and Section 1.613-4(d), App. D, infra,

32a-39a) provide two methods for determining the

constructive “gross income from mining” of an inte-

grated miner-manufacturer. Under both methods the

constructive figure is derived from actual sales data.

If a representative price for the raw material is

established by arm’s-length sales in a relevant market

—by the taxpayer or another miner—that price is the

measuring-stick of constructive mining income for the

raw mineral which the integrated producer uses in

his own manufacturing operations. But if such a

representative price cannot be established because

the raw mineral is not generally sold on the open

market—as in the integrated cement industry—then

the producer’s constructive mining income is derived

under the proportionate profits method from his own

sales price of his manufactured end product.

The objective of the proportionate profits method

is to identify the portion of an integrated producer’s

gross sales that has been produced by the costs ot his

mining operations; that portion is the producer’s

constructive mining income. In_ substance, the

method, long established under the Treasury Regula-

tions, apportions gross sales receipts between mining

and nonmining income in the same ratio as the pro-

ducer’s mining costs bear to its overall costs.

The apportionment is reflected in the following

equation:

Mining costs Gross sales _ Gross income

Total costs of cement from mining

Treasury Regulations, Section 1.613-4(d) (4) (ii)

(App. D, infra, 37a); Arvonia-Buckingham Slate Co.

‘v. United States, supra, 426 F.2d at 486; United

States v. California Portland Cement Co., supra, 413

F.2d at 167 n.2; Whitehall Cement Manufacturing

Co. v. United States, supra, 369 F.2d at 471.

The basic theory of the method is that every dollar

of the producer’s costs, mining and nonmining alike,

is deemed to produce the same proportionate part

o. the profits earned through sales of the first

marketable product; and it is the gross receipts

from such sales which are apportioned in accordance

with the cost ratio. Treasury Regulations, Section

1.613.4(d) (4) (i) (App. D, infra, 35a-86a) ; United

States v. California Portland Cement Co., supra, 413

F.2d at 168; Whitehall Cement Manufacturing Co. v.

United States, supra, 369 F.2d at 471-7485 United —

States v. Portland Cement Co. of Utah, 378 F.2d 91,

92 (10th Cir.), cert. denied, 389 U.S. 975 (1967).

The premise that every dollar of costs produces the

same ratable part of the profits is in accord with long-

settled principles of corporate accounting. See Paton

and Littleton, An Introduction to Corporate Account-

ing Standards 67 (American Accounting Association

1940).

3. (a) The decision below that respondent’s gross

sales of cement should be determined on the assump-

4) 3-

tion that all its cement was sold in bulk is in conflict

with the decisions of the Ninth Circuit in California

Portland Cement Co. and the Third Circuit in White-

hall Cement. Like the decision below, the taxpayer

in California Portland Cement Co. argued that its

profits resulting from sales of bagged cement should

be excluded from the proportionate profits formula

on the ground that the first marketable product ob-

tained from the calcium carbonate rock was bulk

cement.

But the Ninth Circuit rejected this contention, cit-

ing with approval the explicit direction of Treasury

Regulations, Section 1.613-3(d) (1) (iv) (App. D,

infra, 25a) that “bulk and packaged products are

considered to be essentially the same product” and

that with respect to a cement manufacturer, “the fin-

ished cement of various types, in bulk and bags, con-

stitutes the first marketable product or group of

products produced by him” (emphasis added). In

so ruling, the Ninth Circuit observed (413 F.2d at

169) that the treatment of bag and bagging costs

by the court below in Ideal Basic was not consistent

“with other language of that opinion * * *” that

states that “ ‘the sales price of the first marketable

product is to be computed on the identical physical

material that is represented by total mining and non-

mining costs’” (404 F.2d at 125 n.1). Moreover, the

Ninth Cireuit (413 F.2d at 170) agreed with the con-

clusion of the dissenting judge in Ideal Basic that

“Tt]o eliminate all post-manufacturing costs destroys

consideration of the representative market or field

price of the first marketable product, a prime factor

in the application of the equation, and thus seems

* * * to reject the method itself” (404 F.2d at 128).*

In Whitehall Cement, the Third Circuit reached a

similar conclusion prior to the 1968 promulgation of

the definition of “first marketable product” in the

Treasury Regulations.° There, the taxpayer likewise

argued that the costs incident to and premiums

charged for cement sold in bags should be excluded

from the proportionate profits calculation, on the

theory that the bagging costs were more than the

premium so that those costs could not fairly be con-

sidered to have produced a proportionate share of the

manufacturer’s overall profits. The court rejected

this argument as resting on (369 F.2d at 474) “an

erroneous assumption that the packaging costs pro-

duced only the additional revenue derived from the

premiums * * *. It seems reasonable to infer that

the profits realized from the sale of packaged cement,

and these were substantial, were attributable at least

in part to the packaging costs.” The court therefore

4The decision below also conflicts with General Portland

Cement Co. v. United States, 488 F. Supp. 27 (N.D. Tex.

1977), on appeal to the Fifth Circuit (No. 77-2831). There,

the court stated: “To say that the cement in the truck and

barge is the first marketable product is to defy the reality of

the marketing process. Both large and small orders are sold

as cement; the only difference between the two methods of

sale is how the customer receives his cement. Different legal

results which depend upon the mere size of the order of

cement are simply not rational” (438 F. Supp. at 35).

5 See T.D. 6965, 1968-2 Cum. Bull. 265. The current Regu-

lations were promulgated in 1972 and are substantially the

same. T.D. 7170, 1972-1 Cum. Bull. 178. They are retroac-

tively applicable for all years governed by the 1954 Code.

held that the packaging costs must be included in

the denominator of the proportionate profits equation

as A nonmining costs and that the profits attributable

to such costs should be included in gross sales (ibid.).

(b) There is no basis for the theory upon which

the decision below rests that cement in bulk is the

first marketable product so that the bulk price should

be the assumed price for all sales of cement. To be-

gin with, that ruling cannot be squared with the

Treasury Regulations defining first marketable prod-

uct in the context of the cement industry that were

issued pursuant to an express congressional authori-

zation (Section 611(a)) to deal with “the multifari-

ous circumstances which would involve questions of

depletion” Douglas v. Commissioner, 322 U.S. 275,

281 (1944). As the Court has long recognized, such

legislative Regulations are entitled to the same de-

ference as the Code itself unless deemed to be arbi-

trary or contrary to the statutory authorization.

Commissioner v. South Texas Co., 333 U.S. 496, 501

(1948).

But wholly apart from the explicit command of the

Regulations that we submit should govern here, the

conclusion that cement in bulk is a qualitatively dif-

ferent product from cement sold in bags and is there-

fore respondent’s first marketable product materially

distorts the application of the proportionate profits

method. Under that method, the nature of the first

marketable product depends upon its physical and

chemical characteristics. See United States v. Can-

nelton Sewer Pipe Co., supra, 364 U.S. at 85-86.

Neither the quantities nor the packages in which it

is sold, and which determine the per unit price, affect

the nature of the product. Bulk cement and cement

sold in bags is unquestionably the same product.

The container for that product—whether it be a

tank car supplied by the customer or a bag supplied

by respondent—does not alter the physical and chemi-

cal characteristics of the cement. The proportionate

profits method requires an allocation of the actual ,

gross receipts received upon the sale of that product,

and that must be determined, as it was in the Ninth

and Third Circuits, solely on the basis of the prices

in fact charged for the commodity regardless of

variations depending upon such things as packaging.

To exclude from gross sales any part of the sales

proceeds of any cement will not yield the correct

amount of gross income from mining under the pro-

portionate profits formula upon which the statute

allows percentage depletion.

4, The decision below to exclude post-manufactur-

ing costs of bags, bagging, storage, distribution and

sales from the proportionate profits computation is in

conflict with the Ninth Circuit’s decisions in United

States v. California Portland Cement Co., supra, 413

F.2d at 167-172 (costs of bags, bagging, and sales)

and Southwestern Portland Cement Co. v. United

States, 435 F.2d 504, 508-510 (1970) (costs of ship-

ping, bags, bagging and selling) ; the Fourth Circuit’s

decision in Arvonia-Buckingham Slate Co. v. United

States, 426 F.2d 484 (1970) (costs of advertising and

sales); the Third Circuit’s decision in Whitehall Ce-

ment Manufacturing Co. v. United States, 369 F.2d

468 (1966) (costs of bags, bagging, and bulk load-

ing); and the Court of Claims’ decision in Standard

Lime & Cement Co. v. United States, 329 F.2d 939

(1964) (costs of containers, packing, loading and

storing).° These courts have held that these post-

manufacturing costs were incurred to sell the first

marketable product, that a proportionate part of the

profits from the sale of the first marketable product

is allocable to these costs, and that they should be

included in the proportionate profits formula.’

There is no dispute that the costs of storing, ship-

ping, bagging and bags are nonmining costs. The

Treasury Regulations (Sections 1.613-4(d) (3) (i)

and (iii), 1.613-4(g)(3) and (4), App. D, infra,

83a-35a, 42a-43a) so provide; and the court below

as well as the other courts have so held. With re-

spect to selling expenses, the Treasury Regulations

6 The decision below also conflicts with the following dis-

trict court decisions: General Portland Cement Co. v. United

States, 488 F. Supp. 27 (1977) (costs of bags, bagging, load-

ing and storing); and Mississippi Valley Portland Cement

Co. v. United States, 347 F. Supp. 240 (S. D. Miss. 1972)

(costs of shipping, selling, marketing, and packaging).

7In Standard Lime & Cement Co. v. United States, 329 F.2d

939 (1964), the Court of Claims employed a computational ap-

proach different from the ratio formula set forth in the cur-

rent Regulations and adopted by other courts under Treasury

Regulations 118. This approach achieves the same end result,

however, because the same basic theory was applied. Standard

Lime reflects the literal description of the proportionate

profits method in the 1989 Code Regulations. Under that

description, post-manufacturing costs, together with their

proportion of the profits, are subtracted from gross sales.

This manner of working back from gross sales maintains

the proper correspondence between a constructive income

figure and related costs at any point in an integrated pro-

ducer’s operations.

(Section 1.613-4(d) (8) (iv) and 1.613-5(c) (4) (ii),

App. D, infra, 35a-43a) provide that they are non-

mining costs except when a taxpayer shows that an

unintegrated miner or producer typically incurs

selling expenses, in which case such expenses are

allocated between mining and nonmining costs. Re-

spondent, however, made no such showing in this

case. Accordingly, the courts below correctly held

them to be nonmining costs. The only question is

whether these nonmining costs are included as such

in the proportionate profits computation.

Contrary to the decision below, the Regulations

and the cases including these costs in the formula

are correct. No expenses may be eliminated from the

proportionate profits method, for the underlying ac-

counting theory is abrogated unless a producer’s

gross sales are allocated in accordance with a cost

fraction which includes in its denominator all of the

costs producing the sales. The determination of the

integrated miner-manufacturer’s “gross income from

mining” requires an allocation of all its income from

sales of the first marketable product between the

mining and nonmining phases of the company’s op-

erations. All costs and all of the profit must be allo-

cated to either the mining or the nonmining part of

the operation. If an item of expense in fact results

from the mining phase of the business, it should be

included in the “gross income from mining,” and

also carry into “gross income from mining” its rat-

able share of the company’s profit or loss. By the

same token, every cost that is attributable to the non-

mining operations, together with its allocable share

of profit or loss, must be excluded from the depletion

base. Otherwise the proportionate profits formula

will be distorted with the result that the depletion

allowance will not be restricted to its intended ambit,

the return of the miner’s capital interest in de-

pletable materials. United States v. California Port-

land Cement Co., supra, 413 F.2d at 172. |

Here, as in its previous decision in Jdeai Basic In-

dustries, the court below refused to recognize that all

of the costs of producing and selling cement had to be

taken into account in determining the costs ratio. It

correctly reaffirmed its prior holding that “the costs

of bagging and of bags were not mining costs * * *”

(App. B, infra, 15a). But it erroneously refused to

apply the basic theory of the proportionate profits

method to these costs, in holding that they “should

be excluded under an application of the proportionate

costs doctrine” (ibid.).

By excluding these costs from the denominator

(total costs) of the costs fraction, the decision below

has in effect put part of the post-manufacturing

costs and their allocable share of profits within re-

spondent’s depletion base. This distortion is a con-

sequence of the court’s requiring the allocation of

sales income (erroneously limited to bulk cement) by

a ratio that includes only mining and manufacturing

costs in the denominator. As the dissenting judge

observed in Ideal Basic Industries, in terms that are

equally appropriate here, this decision “reaches a

result that is a rejection of the basic theory of the

proportionate profit method itself” (404 F.2d at 127).

The court of appeals’ persistent rejection of this well-

established method of computing the depletion deduc-

tion should not be permitted to stand.

CONCLUSION

The petition for a writ of certiorari should be

granted.

Respectfully submitted.

WADE H. MCCRER, JR.

Solicitor General

M. CARR FERGUSON

Assistant Attorney General

STUART A, SMITH

Assistant to the Solicitor General

JONATHAN S. COHEN

DAVID ENGLISH CARMACK

Attorneys

JUNE 1980

APPENDIX A

T. C. Memo. 1977-137

UNITED STATES TAX COURT

Docket No. 6306-73

Filed May 9, 1977

PORTLAND CEMENT Co. OF UTAH, PETITIONER

COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Glen E. Fuller and Jack R. Decker, for the peti-

tioner.

S. Clay Freed, for the respondent.

MEMORANDUM FINDINGS OF FACT

AND OPINION

FAY, Judge: Respondent determined deficiencies

in petitioner’s Federal income tax as follows:

FYE Deficiency

March 81, 1970 $44,200

March 81, 1971 41,509

March 81, 1972 7,175

The deficiencies pertain to petitioner’s method of

computing percentage depletion under section 613.

1 All section references are to the Internal Revenue Code

of 1954, as amended, unless otherwise indicated.

Specifically, we are to decide whether petitioner has

made a proper application of the proportionate prof-

its method of determining gross income from min-

ing.

FINDINGS OF FACT

Petitioner is a Utah corporation which main-

tained its principal place of business at Salt Lake

City, Utah, when the petition herein was filed. For

each of the years in issue it filed a corporate in-

come tax return with the Western Service Center,

Ogden, Utah.

Petitioner is an integrated miner-manufacturer of

Portland cement. It has for many years engaged in

the quarrying of an argillaceous limestone rock,®

known in the trade as cement rock, and in the proc-

essing of that rock into finished Portland cement.

The manufacture of Portland cement begins with

the mining of cement rock. Petitioner obtains ce-

ment rock from its own quarry located 12 miles

from its Salt Lake City processing plant. The ce-

ment rock is first blasted free of the mountainous

quarry face, then pushed by bulldozer to the quarry

floor. Secondary blasting is employed, if necessary,

to further reduce the size of large boulders. The loose

rock is then transported to “reduction” machinery

where it passes through a jaw crusher and an im-

pacter which further reduce the material to a size

of less than one inch. The crushed material is

2 Referred to as “calcium carbonates” or “limestone” in

sec. 613 (b) (7), I.R.C. 1954.

stored temporarily at the quarry in bins awaiting

loading into trucks for transportation to the proc-

essing plant.

Arriving at the processing plant, the material is

unloaded and placed in open stockpiles. The mate-

rial is then fed into rod-ball mills which grind the

rock to a fineness so that 75 percent volume passes

through a 200 mesh sieve. During this grinding

process, water is added to the powder and a “slurry,”

a very fine mud, is formed. The slurry is stored in

tanks where it is continually agitated to maintain a

uniform mixture. The mining phase of the opera-

tion concludes at this point.

During the manufacturing phase, the liquid slurry

is fed into rotary kilns and burned. The heat of

the kiln expells moisture from the material and con-

verts carbonates to oxides. As the material is heat-

ed to a point of incipient fusion, complex silicates

and aluminates are formed by chemical reactions oc-

curring inside the kiln. The result of the burning

process is a hard, glass-like “clinker.” The clinker

is cooled and later ground with purchased gypsum

to produce finished cement.

The rock in taxpayer’s quarry varies in chemical

composition. Certain areas within the quarry do not

contain all the ingredients necessary to produce fin-

ished Portland cement. When rock is quarried from

these areas it becomes necessary to add to the ce-

ment rock supplementary chemical materials. The

various chemical supplements are added to the ce-

ment rock during the grinding phase in the rod-ball

mill, High lime rock is added to correct any cal-

cium carbonate deficiency in the quarried rock; iron

slag is added to correct any iron deficiency; silica

is added to compensate for lacking silica oxides.

If the required amounts of calcium carbonates,

iron and silica oxides are not present in the slurry

as it is introduced into the kiln, chemical actions re-

quired to produce a clinker from which Portland ce-

ment can be made will not occur. It is only when

the proper proportions of materials are introduced

into the rod-ball mill that the necessary chemical

reactions will take place during the burning in the

kilns. Frequent chemical analyses are made by peti-

tioner’s chemists to ensure that the slurry is of a

proper composition for making Portland cement.

After final grinding, finished cement is placed in

storage silos to await sales to customers. Petition-

er’s finished cement is sold in two ways. Most of

petitioner’s output is sold in bulk in tank cars, load-

ing directly from the storage silos. A small portion

of the output is run from the storage silo into a bin

above a bagging machine where it is sealed in pa-

per bags and thereafter sold in that form.’

8’ The parties have agreed upon the amounts of most of the

expenses that are required in computing petitioner’s depletion

deduction. Since this controversy involves the application of

the depletion computation, a recital of these amounts would

not furnish an aid to an understanding of this case. Accord-

ingly, they are not set forth in our findings of fact.

OPINION

In computing the amount of its gross income from

mining, a component necessary to arriving at its

percentage depletion allowance for the years in is-

sue, petitioner utilized the proportionate profits

method of computation. See sec. 613.

According to the regulations:

The proportionate profits method of computa-

tion is applied by multiplying the taxpayer’s

gross sales * * * of his first marketable product

or group of products * * * by a fraction whose

numerator is the sum of all the costs allocable to

those mining processes which are applied to pro-

duce, sell, and transport the first marketable

product or group of products, and whose de-

nominator is the total of all the mining and non-

mining costs paid or incurred to produce, sell,

and transport the first marketable product or

group of products * * *. The method as de-

scribed herein is merely a restatement of the

method formerly set forth in the second sentence

of Regulations 118, § 39.28(m)-1l(e) (3) (1939

Code). The proportionate profits method of

computation may be illustrated by the following

equation:

Mining Costs __ Gross Income

Total Costs ~ arots Sales = from Mining.

[Sec. 1.613-4(d)4(ii), Income Tax Regs.; em-

phasis supplied. ] ‘

* The depletion regulations are legislative in nature, having

the force and effect of law. Sec. 611(a).

The controversy in this matter centers on the

costs which constitute “total costs” in the above

formula. The resolution of this question depends in

turn upon the meaning of the term “first market-

able product” as stated in the regulation.

Petitioner sells finished cement both in bulk and

in bags. Since the difference between the bulk and

bagged price does not exceed the cost of the bags |

and bagging, petitioner would have a greater deple-

tion base if the proportionate profits computation

were applied to the value of its bulk cement, and

the bags and bagging costs entirely excluded from

the formula.

On its Federal income tax returns for the years

in issue, petitioner took the position that bulk ce-

ment, rather than cement in bags, constituted its

first marketable product, and applied the formula

accordingly in computing its depletion deduction.

Respondent, on the other hand, would have us in-

clude the costs of bags and bagging in the “total

costs” portion of the formula, thereby decreasing

the ultimate amount of “gross income from mining”

and the corresponding depletion deduction. Addi-

tionally, respondent would further include in the

formula the costs incurred in selling, shipping, and

storing, along with the indirect costs attributable

to these activities.

The taxpayer in this case maintains its principal

place of business in Salt Lake City, Utah, and, there-

fore, an appeal of the decision herein would lie in

the Tenth Circuit. The Court of Appeals for the

Tenth Circuit previously considered this issue in

United States v. Ideal Basic Industries, Inc., 404

F.2d 122 (10th Cir. 1968).°

In that case the court held bulk cement to be the

first marketable product, stating at pages 125-126:

We conclude that “first marketable product”

is the proper sales price to which the applica-

tion of the formula was intended, therefore, the

costs of bags, bagging, and bulk loading should

be eliminated from all parts in the formula.

“Consequently we must hold that those packing

and loading costs are indirect costs which are not

incurred for the benefit of the entire operation

and as such cannot be included in taxpayer’s

computation of gross income from the property

at kiln feed.” Standard Lime & Cement Co. v.

United States, 329 F.2d 939, 948, 165 Ct. Cl.

180 (1964) (emphasis added); accord, United

Salt Corp., 40 T.C. 359 (1963). Equally com-

pelling is the simple logic that bulk cement is

the first marketable product,’ bagged cement is

the second marketable product, as for example

“sakrete” * would be a third marketable prod-

uct.

2 Bulk cement is the first marketable product because

it cum be sold. * * *

8’ “Sakrete” is a bagged mixture of cement, sand, and

gravel to which water may be added to make concrete.

5 See also Portland Cement Company of Utah v. United

States, 412 F.2d 894 (10th Cir. 1969), in which the Tenth

Circuit followed United States v. Ideal Basic Industries, Inc.,

404 F.2d 122 (10th Cir. 1968), in a subsequent case involving

the petitioner herein on the identical issue.

In the present case petitioner contends simply that

we are bound by this holding pursuant to the rule

set forth in Golsen v. Commissioner, 54 T.C. 742

(1970), affd. 445 F.2d 985 (10th Cir. 1971), cert.

denied 404 U.S. 940 (1971).

Respondent, relying on the holdings in Commis-

sioner v. Sunnen, 383 U.S. 591 (1948), and CBN

Corporation v. United States, 364 F.2d 393 (Ct. Cl.

1966), cert. denied 386 U.S. 981 (1967), contends

that certain amendments to the pertinent regulations

adopted subsequent to the Tenth Circuit’s decision in

Ideal Basic have worked a change in the legal atmos-

phere sufficient to cause the Tenth Circuit to re-

examine their previously expressed position. As such,

he argues, the Tenth Circuit’s position insofar as we

are concerned is no longer a foregone conclusion and

the Golsen rule is therefore inapplicable in this in-

stance.

Thus, at this point, it becomes our task to deter-

mine the extent, if any, by which the regulation

changes have affected the definition of the term “first

marketable product.”

In 1972 the sections of the regulations dealing with

the proportionate profits method of computation were

revamped. At that time the main definitional por-

tions of the regulations describing the proportionate

profits method were carried over intact. Several new

portions, however, were added.

In support of his position herein, respondent relies

principally on the following language, added subse-

quent to the Ideal Basic decision, contained in sec-

tion 1.613-4(d) (3) (iii) (a), Income Tax Regs.:

(iii) In determining gross income from min-

ing by use of methods based on the taxpayer’s

costs—

(a) The costs attributable to containers,

bags, packages, pallets, and similar items

as well as the costs of materials and labor

attributable to bagging, packaging, palletiz-

ing, or similar operations shall be consid-

ered as nonmining costs.

Since this addition specifically states that the costs

of bags and bagging are to be treated as nonmining

costs, respondent concludes that such costs are now

necessarily includable in the formula as an element of

“total costs” rather than being eliminated entirely

as the Tenth Circuit directed in Ideal Basic.

Respondent’s view, however, overlooks a_ pivotal

consideration. Notwithstanding the new regulation’s

specific mention of bags and bagging costs, such addi-

tional language does not purport to alter the defini-

tion of the makeup of the elements which constitute

the first marketable product.® Rather, such change

merely clarifies the classification among certain costs

which are common to almost all integrated mining-

manufacturing operations.’

6 Sec. 1.613-4(d)4 (iv), which defines the term “first market-

able product,” was transferred completely intact from the

old to the new regulatory material.

7 Indeed, the Tenth Circuit takes no issue with the view

that the cost of bags and bagging constitutes nonmining

expenses. See Ideal Basic Industries, supra at 125.

10a

Thus, once bulk cement is determined to be the

first marketable product, the costs of bags and bag-

ging become an element of producing a second mar-

ketable product—bagged cement; hence, these costs

are of no consequence in determining gross income

from the sale of the first marketable product. Given

the fact that in the Tenth Circuit’s view, bulk ce-

ment—the first marketable product—is produced be-

fore the bagging process commences, the amended

regulation’s mere reference to such bagging costs

does not support respondent’s claim for mandatory

inclusion in the formula.

With regard to storing, shipping, and selling costs

involved in the present case, the result is the same.

As further stated in Ideal Basic:

The advertising, promotional, and selling costs

are not a proper part of the computation. These

costs, like bagging (packing) and loading costs

are overhead charges properly applicable to fin-

ished cement after it has become “first market-

able product.” * * *

Similarly, the court directed that the costs of operat-

ing storage warehouses and distribution terminals

and the transportation en route be eliminated from

the formula, 404 F.2d at 126.

We conclude that the issue herein was fully aired

and decided by the Tenth Circuit in Ideal Basic,

supra.® The premise underlying that decision re-

8 This case marks petitioner’s sixth round in depletion-

related litigation. See Portland Cement Company of Utah v.

lla

mained unaffected by the regulation change. We are

therefore bound to follow that decision in accord-

ance with the requirements of Golsen v. Commis-

sioner, supra.

To reflect the foregoing conclusions,

Decision will be entered under Rule 155.

United States, 412 F.2d 894 (10th Cir. 1969) ; United States

Vv. Portland Cement Company of Utah, 8378 F.2d 91 (10th Cir.

1967) ; 388 F.2d 798 (10th Cir. 1964) ; 315 F.2d 169 (10th

Cir. 19638) ; 293 F.2d 826 (10th Cir. 1961).

12a

APPENDIX B

PUBLISH

UNITED STATES COURT OF APPEALS

TENTH CIRCUIT

No. 78-1290

PORTLAND CEMENT COMPANY OF UTAH,

a corporation, APPELLEE

Vv.

COMMISSIONER OF INTERNAL REVENUE, APPELLANT

On Appeal From The Decision Of The

United States Tax Court

[Filed Feb. 5, 1980]

David English Carmack, Department of Justice,

Washington, D.C. (M. Carr Ferguson, Assistant At-

torney General, Gilbert E. Andrews and Grant W.

Wiprud, attorneys, Tax Division, Department of Jus-

tice, Washington, D.C., with him on the brief), for

Appellant.

Glen E. Fuller, Salt Lake City, Utah, for Appellee.

13a

Before SETH, Chief Judge, McKay and LoaaNn, Cir-

cuit Judges.

PER CURIAM.

This is another chapter in the litigation concern-

ing the application of the depletion allowance to the

mining of cement rock and the manufacture of ce-

ment. The appellee in its brief states that this is its

sixth appearance in this court on the issue. The fifth

was in Portland Cement Co. of Utah v. United States,

412 F.2d 894 (10th Cir.). We also handed down an

opinion in United States v. Ideal Basic Industries,

Inc., 404 F.2d 122 (10th Cir.), under the 1968 Regu-

lations. The issue before us is essentially the same as

in the two cases cited.

This appeal is from the decision of the Tax Court

entered in Docket No. 6306-73 as T.C. Memo 1977-

137, 36 T.C.M. 578. This decision held that since

the case arose in this circuit, it would be controlled

by United States v. Ideal Basic Industries, Inc., 404

F.2d 122 (10th Cir.). The Tax Court held that the

changes in the Treasury Regulations in 1972

(§ 1.613-4(d)(4)) would not bring about a change

in the result reached in Jdeal Basic. It determined

that the basic consideration was that of the “first

marketable product.” It noted that the 1972 Regu-

lations carried over the same provisions as were re-

lied on in Ideal Basic Industries in the 1968 Regu-

lations. We can add little, if anything, to the analysis

, l4a

made by the Tax Court, and we agree with the con-

clusion reached. The Government here seeks to have

another review of the Jdeal Basic case, and of the

previous case concerning this same appellee. The

Ninth Circuit has apparently reached a different re-

sult—at least as to non-mining costs—in United

States v. Calif. Portland Cement Co., 413 F.2d 161

(9th Cir.).

As the Tax Court indicated, the “pivotal considera-

tion” is the determination under the Regulations of

what is the “first marketable product.” We expressly

held in Jdeal Basic that this product was “bulk

cement.” In the process followed by appellee, when

the firing of the slurry in the kilns is complete, a

clinker remains. This is then finely ground, and the

product is finished cement. This goes into storage

silos and is “bulk cement.” It is loaded from these

silos directly into tank cars and so sold in bulk to

customers. Over 90% of appellee’s sales are made in

this manner. Some of the bulk cement is moved from

the storage silos to a bin which is part of a bagging

machine which in turn puts the cement into paper

bags and seals the bags. The bagged cement is then

sold as such to smaller users. The Government seeks

to have “bagged cement” be the “first marketable

product,” and to so include the expenses associated

with the bagging. This increase in expenses under

the formula would reduce the depletion deduction.

As was held in our previous opinions, “bulk cement”

is marketable as such, and under the Regulations it

is the “first marketable product.” The bagged cement

15a

is the next stage, and it is, as the Tax Court indi-

cated, the second marketable product.

The Government in its argument ignores the “first

marketable” aspect of the Regulation, and would

move to the second process—the bagging—because

the cement in the bags is the same as in the bulk

silos. It is obvious that both are “cement,” but it is

equally apparent that it is “first marketable” as bulk

cement, not as bagged cement.

The Treasury Regulations were not changed since

Ideal Basic as to the definition of “first marketable

product.” This portion of the old Regulations was

carried over intact into the 1972 Regulations as

§ 1.613-4(d) (4) (iv). These provisions were the

basis for the Ideal Basic decision, and no reason for a

change has been presented.

The 1972 Regulations added § 1.613-4(d) (3) (iii)

(a) relating to integrated mining activities in gen-

eral, This provided that costs attributable to bagging,

palletizing, etc., “shall be considered as nonmining

costs.” In Jdeal Basic, we expressly held that the

costs of bagging and of bags were not mining costs,

and should be excluded under an application of the

proportionate costs doctrine. These costs thus had no

part there in the determination of the income from

the first marketable product. They have no part here

when /deal Basic is applied.

The appellee expresses an unhappiness with the

proportionate profits doctrine applied in Jdeal Basic

from the Treasury Regulations. It is, as therein de-

scribed, artificial, but a device necessary for practical

16a

administration. It is obviously unrealistic in some

particular instances. As this appeal has developed,

we will not consider it as an issue to be reviewed

again.

AFFIRMED.

17a

APPENDIX C

UNITED STATES COURT OF APPEALS

FOR THE TENTH CIRCUIT

January Term—February 5, 1980

Before The Honorable Oliver Seth, Chief Circuit

Judge, The Honorable Monroe G. McKay, Circuit

Judge, and The Honorable James K. Logan, Cir-

cuit Judge

PORTLAND CEMENT COMPANY OF UTAH,

a corporation, PETITIONER-APPELLEE

vs.

COMMISSIONER OF INTERNAL REVENUE,

RESPONDENT-APPELLANT

JUDGMENT

No. 78-1290

This cause came on to be heard on the record on

appeal from the United States Tax Court, and was

argued by counsel.

Upon consideration whereof, it is ordered that the

judgment of that court is affirmed.

/8/ Howard K. Phillips

Howarp K. PHILLIPS

Clerk

18a

APPENDIX D

Internal Revenue Code of 1954 (26 U.S.C.):

Sec. 611. ALLOWANCE OF DEDUCTION FOR DE-

PLETION.

(a) General Rule.—In the case of mines, oil

and gas wells, other natural deposits, and tim-

ber, there shall be allowed as a deduction in com-

puting taxable income a reasonable allowance

for depletion and for depreciation of improve-

ments, according to the peculiar conditions in

each case; such reasonable allowance in all cases

to be made under regulations prescribed by the

Secretary or his delegate. For purposes of this

part, the term “mines” includes deposits of

waste or residue, the extraction of ores or min-

erals from which is treated as mining under

section 618(c). In any case in which it is as-

certained as a result of operations or of develop-

ment work that the recoverable units are greater

or less than the prior estimate thereof, then such

prior estimate (but not the basis for depletion)

shall be revised and the allowance under this

section for subsequent taxable years shall be

based on such revised estimate.

* * * * *

Sec. 618. PERCENTAGE DEPLETION.

(a) [as amended by Section 13(e), Revenue

Act of 1962, Pub. L. No. 87-834, 76 Stat. 960]

General Rule.—In the case of the mines, wells,

and other natural deposits listed in subsection

(b), the allowance for depletion under section

611 shall be the percentage, specified in subsec-

tion (b), of the gross income from the property

19a

excluding from such gross income an amount

equal to any rents or royalties paid or incurred

by the taxpayer in respect of the property. Such

allowance shall not exceed 50 percent of the tax-

payer’s taxable income from the property (com-

puted without allowance for depletion). For pur-

poses of a preceding sentence, the allowable de-

ductions taken into account with respect to ex-

penses of mining in computing the taxable income

from the property shall be decreased by an

amount equal to so much of any gain which (1)

is treated under section 1245 (relating to gain

from disposition of certain depreciable property)

as gain from the sale or exchange of property

which is neither a capital asset nor property

described in section 1231, and (2) is properly

allocable to the property. In no case shall the

allowance for depletion under section 611 be less

than it would be if computed without reference

to this section.

(b) Percentage Depletion Rates— * * *

* * * * *

(7) [as amended by Section 302(a), Pub-

lice Debt and Tax Rate Extension Act of

1960, Pub. L. No. 86-564, 74 Stat. 290; Sec-

tion 6(a), Act of September 2, 1964, Pub. L.

No. 88-571, 78 Stat. 857; Sections 208(a)

and 209(a), Foreign Investors Tax Act of

1966, Pub. L. No. 89-809, 80 Stat. 1539. In

effect for tax years beginning on or prior to

October 9, 1969.] 15 percent—[a]ll other

minerals (including, but not limited to, aplite,

barite, borax, calcium carbonates, diatomace-

ous earth, dolomite, feldspar, fullers earth,

garnet, gilsonite, granite, limestone, magne-

20a

site, magnesium carbonates, marble, mollusk

shells (including clam shells and oyster

shells), phosphate rock, potash, quartzite,

slate, soapstone, stone (used or sold for use

by the mine owner or operator as dimension

stone or ornamental stone), thenardite, tri-

poli, trona, and (if paragraph (1)(C) does

not apply) bauxite, flake graphite, fluor-

spar, lepidolite, mica, spodumene, and tale,

including pyrophyllite), except that, unless

sold on bid in direct competition with a bona

fide bid to sell a mineral listed in paragraph

(3), the percentage shall be 5 percent for

any such other mineral (other than slate

to which paragraph (5) applies) when

used, or sold for use, by the mine owner or

operator as rip rap, ballast, road material,

rubble, concrete aggregates, or for similar

purposes. For purposes of this paragraph,

the term “all other minerals” does not in-

clude— P

(A) soil, sod, dirt, turf, water, or

mosses ; or

(B) minerals from sea water, the

air, or similar inexhaustible sources.

(7) [as amended by Section 501(a), Tax

Reform Act of 1969, Pub. L. No. 91-172, 83

Stat. 487; Section 501(b) (2), Tax Reduction

Act of 1975, Pub. L. No. 94-12, 89 Stat. 26.

In effect for tax years beginning after Oc-

tober 9, 1969.] 14 percent—[a]ll other min-

erals, including, but not limited to, aplite, bar-

ite, borax, calcium carbonates, diatomaceous

earth, dolomite, feldspar, fullers earth, gar-

net, gilsonite, granite, limestone, magnesite,

magnesium carbonates, marble, mollusk

21la

Shells (including clam shells and oyster

Shells), phosphate rock, potash, quartzite,

slate, soapstone, stone (used or sold for use

by the mine owner or operator as dimension

stone or ornamental stone), thenardite,

tripoli, trona, and (if paragraph (1) (C)

does not apply) bauxite, flake graphite,

fluorspar, lepidolite, mica, spodumene, and

tale (including pyrophyllite), except that,

unless sold on bid in direct competition

with a bona fide bid to sell a mineral listed

in paragraph (3), the percentage shall be

5 percent for any such other mineral (other

than slate to which paragraph (5) applies)

when used, or sold for use, by the mine

owner or operator as rip rap, ballast, road

material, rubble, concrete aggregates, or for

Similar purposes. For purposes of this

paragraph, the term “all other minerals”

does not include—

(A) soil, sod, dirt, turf, water or

mosses; or

(B) minerals from sea water, the

air, or similar inexhaustible sources.

Public Debt and Tax Rate Extension Act of

1960, supra] Definition of Gross Income From

Property.—For purposes of this section—

(1) Gross income from the property.—

The term “gross income from the property”

means, in the case of a property other than

an oil or gas well, the gross income from

mining.

22a

(2) Mining—The term “mining” in-

cludes not merely the extraction of the ores

or minerals from the ground but also the

treatment processes considered as mining

described in paragraph (4) (and the treat-

ment processes necessary or incidental there-

to), and so much of the transportation of

ores or minerals (whether or not by common

carrier) from the point of extraction from

the ground to the plants or mills in which

such treatment processes are applied there-

to as is not in excess of 50 miles unless the

Secretary or his delegate finds that the phy-

sical and other requirements are such that

the ore or mineral must be transported a

greater distance to such plants or mills.

. + . + «

(4) Treatment processes considered as

mining.—* * *

* * * * *

. (F) in the case of calcium carbo-

nates and other minerals when used in

making cement—all processes (other

than preheating of the kiln feed) ap-

plied prior to the introduction of the

kiln food into the kiln, but not includ-

ing any subsequent process;

* + 7 * +

Treasury Regulations 118 (1939 Code) :

§ 39.23(m)-1 Depletion of mines, oil and gas

wells, other natural deposits, and timber; de-

preciation of improvements.

* * * * *

23a

(e) As used in sections 114(b)(3) and 114

(b) (4) (A) and §§ 39.23(m)-1 to 39.23(m)-19,

inclusive, the term “gross income from the

property” means the following:

* * + * *

(8) If the taxpayer sells the crude mineral

product of the property in the immediate vicin-

ity of the mine, “gross income from the prop-

erty’ means the amount for which such product

was sold, but, if the product is transported or

processed (other than by the ordinary treat-

ment processes described below) before sale,

“gross income from the property” means the

representative market or field price (as of the

date of sale) of a mineral product of like kind

and grade as beneficiated by the ordinary treat-

ment processes actually applied, before transpor-

tation of such product (other than transporta-

tion treated, for the taxable year, as mining).

If there is no such representative market or

field price (as of the date of sale), then there

shall be used in lieu thereof the representative

market or field price of the first marketable

product resulting from any process or processes

(or, if the product in its crude mineral state is

merely transported, the price for which sold)

minus the costs and proportionate profits at-

tributable to the transportation (other than

transportation treated, for the taxable year, as

mining) and the processes beyond the ordinary

treatment processes. If the taxpayer establishes

to the satisfaction of the Commissioner that an-

other method of computation, other than the

computation of profits proportionate to costs,

clearly reflects the gross income from the prop-

24a

erty, then such gross income shall be computed

by the use of such other method.

* * * * *

Treasury Regulations on Income Tax (1954 Code)

(26 C.F.R.):

§ 1.613-3. Gross income from the property.

* * * * *

(d) Sales after the application of nonmining

processes where a representative market of field

price cannot be ascertained—(1) Computation

of gross income from the property by use of the

proportionate profits method.

* * * * *

(iii) Those costs which are paid or incurred

by the taxpayer to produce, sell, and transport

the first marketable product or group of prod-

ucts, and which are not directly identifiable with

either a particular mining process or a particu-

lar nonmining process shall be properly appor-

tioned to mining and to nonmining. In the

absence of any specific provision of this section

providing an apportionment method, such costs

shall be apportioned by use of a method which

is reasonable in the circumstances. One method

which may be reasonable in a particular case is

an allocation based on the proportion that the

direct costs of mining processes and the direct

costs of nonmining processes bear to each other.

For example, the salary of a corporate officer

engaged in overseeing all of the taxpayer’s proc-

esses is an expense which would normally be ap-

portioned on the basis of the ratio between the

direct costs of mining and nonmining processes.

—

25a

On the other hand, an expense such as work-

men’s compensation premiums would normally

be apportioned on the basis of direct labor costs.

For the rule relating to selling expenses, see

paragraph (c) of § 1.613-4.

(iv) As used in this section, the term “first

marketable product or group of products” means

the product (or group of essentially the same

products) produced by the taxpayer as a result

of the application of nonmining processes, in the

form or condition in which such product or prod-

ucts are first marketed in significant quantities

by the taxpayer or by others in the taxpayer’s

marketing area. For this purpose, bulk and

packaged products are considered to be essen-

tially the same product. The first marketable

product or group of products does not include a

product or group of products additionally re-

fined, beneficiated, altered, or manufactured as

a result of the application of additional non-

mining processes. For example, if a cement

manufacturer sells his own finished cement of

various types in bulk and bags and also sells

concrete blocks or dry ready-mix aggregates con-

taining additivies, the finished cement of various

types, in bulk and bags, constitutes the first

marketable product or group of products pro-

duced by him. Similarly, if an integrated iron

ore and steel producer sells both pig iron in

various sizes and rolled sheet iron or shapes, his

first marketable product is the pig iron in its

various sizes. Further, if an integrated clay and

brick producer sells both unglazed bricks and

tiles of various shapes and sizes and additionally

manufactured bricks and tiles which are specially

26a

glazed, the unglazed products, both packaged and

unpackaged, constitute his first marketable prod-

uct or group of products.

(v) As used in this paragraph, the term

“sross sales (actual or constructive)” means the

total of the taxpayer’s actual sales to others of

the first marketable product or group of prod-

ucts, plus the taxpayer’s constructive sales of

the first marketable product or group of prod-

ucts used or retained for use in his own subse-

quent operations. The prices at which actual or

constructive sales are made are to be determined

in accordance with the principles set forth in this

paragraph and in paragraphs (b), (c), and (e)

of this section, as appropriate. In the case of

constructive sales of the taxpayer’s first market-

able product or group of products, the taxpayer

shall attach to his return a statement indicating

the price or prices used by him in computing the

representative market or field price for such

product or products, and the source of his infor-

mation as to such price or prices. The prices at

which actual or constructive sales are made shall

not be determined by reference to prices estab-

lished in transactions between members of a

controlled group. See paragraph (a) of § 1.482-1

for the definitions of the terms “controlled” and

“sroup”.

# * * * *

(4) Treatment of particular items in comput-

ing gross income from the property by use of

the proportionate profits method or another ap-

proved method based on the taxpayer’s costs.

(i) Except as specifically provided elsewhere in

this section, when determining gross income from

27a

the property by use of the proportionate profits

method or any other approved method which is

based on the taxpayer’s costs, the costs attribut-

able to mining transportation shall be treated

as mining costs, and the costs attributable to

nonmining transportation shall be treated as non-

mining costs. Accordingly, except as specifically

provided elsewhere in this section, all profits

attributable to mining transportation shall be

treated as mining profits, and all profits at-

tributable to nonmining transportation shall be

treated as nonmining profits. For this purpose,

mining transportation means so much of the

transportation of ores or minerals (whether or

not by common carrier) from the point of ex-

traction from the ground to plants or mills in

which other mining processes are applied thereto

as is not in excess of 50 miles or, if the taxpayer

files an application pursuant to paragraph (h)

of this section and the Commissioner finds that

both the physical and other requirements are

such that the ores or minerals must be trans-

ported a greater distance to such plants or mills,

the transportation over the greater distance.

Further, for this purpose, nonmining transpor-

tation includes the transportation (whether or

not by common carrier) of ores, minerals, or the

products produced therefrom, from the point of

extraction from the ground to nonmining facili-

ties, or from a mining facility to a nonmining

facility, or from one nonmining facility to

another, or from a nonmining facility to the cus-

tomers who purchase the taxpayer’s first market-

able product or group of products. See para-

graph (e) (2) of this section for provisions relat-

28a

ing to purchased transportation to the customer,

and paragraph (g)(3) of this section for pro-

visions relating to transportation the primary

purpose of which is marketing or distribution.

In the absence of other methods which the dis-

trict director determines will clearly reflect the

costs of the various phases of transportation, the

cost attributable to nonmining transportation

shall be an amount which is in the same ratio

to the costs incurred for the total transporta-

tion as the distance of the nonmining transpor-

tation is to the distance of the total transporta-

tion. Where the plants or mills in which mining

processes are applied to ores or minerals are in

excess of 50 miles from the point of extraction

from the ground (or in excess of a greater dis-

tance approved by the Commissioner), the costs

incurred for transportation to such plants or

mills in excess of 50 miles (or of such greater

distance) shall be treated as nonmining costs in

determining gross income from mining. Accord-

ingly, all profits attributable to such excess

transportation are treated as nonmining profits.

However, except in the case of transportation

performed in conveyances owned or leased by the

taxpayer, the preceding sentence shall apply only

to taxable years beginning after November 30,

1968.

+ + * * *

(iii) In determining gross income from the

property by use of the proportionate profits

method (or any other approved method which is

based on the taxpayer’s costs) —

(a) The costs attributable to containers, bags,

packages, pallets, and similar items as well as

29a

the costs of materials and labor attributable to

bagging, packaging, palletizing, or similar opera-

tions shall be considered as nonmining costs.

(b) The costs attributable to the bulk loading

of manufactured products shall be considered as

nonmining costs.

warehouses or distribution terminals for manu-

factured products shall be considered as non-

mining costs.

Accordingly, all profits attributable thereto are

treated as nonmining profits.

(iv) In computing gross income from the

property by means of the proportionate profits

method or any other approved method based on

the taxpayer’s costs, the principles set forth in

paragraph (c) of § 1.613-4 shall apply when de-

termining whether selling expenses and trade

association dues are to be treated, in whole or

in part, as mining costs or as nonmining costs.

To the extent that selling expenses and trade as-

sociation dues are treated as nonmining costs, all

profits attributable thereto are treated as non-

mining profits.

* * * * *

(e) Reductions of sales price in computing

gross income from the property— * * *

* * * * *

(2) Purchased transportation to the cus-

tomer. ° * *

* * * * *

(ii) In the case of a taxpayer computing

gross income from mining under the provisions

of paragraph (d) (1) of this section, the cost of

purchased transportation to the customer (as de-

30a

fined in subdivision (iii) of this subparagraph)

shall be excluded from the taxpayer’s gross sales

of his first marketable product or group of prod-

ucts (after any adjustments required by sub-

paragraph (1) of this paragraph) and from the

denominator of the proportionate profits frac-

tion, without attributing profits to the cost of

such transportation. Similar transportation cost

adjustments may be made, if appropriate, in the

case of methods of computation which are ap-

proved under paragraph (d)(2) of this section

and which are based on the taxpayer’s costs.

For the treatment of costs and profits attribut-

able to transportation which does not meet the

requirements of subdivision (iii) of this sub-

paragraph. See paragraph (d)(4)(i) of this

section.

(iii) For purposes of this section, the term

“purchased transportation to the customer”

means, in general, nonmining transportation

from the taxpayer’s mine or plant to the cus-

tomer—

(a) Which is performed in conveyances owned

or leased by persons other than the taxpayer,

rather than in conveyances owned or leased by

the taxpayer;

(b) Which is performed solely to deliver the

taxpayer’s minerals or mineral products to the

customer, rather than to transport such minerals

or products for packaging or other additional

processing by the taxpayer (other than inci-

dental storage or handling) ; and

a way that the taxpayer ordinarily does not earn

any profit with respect to such transportation.

3la

For purposes of the preceding sentence, trans-

portation which is performed by a person con-

trolling or controlled by the taxpayer (within

the meaning of paragraph (a) (3) of § 1.482-1)

shall be deemed to have been performed in con-

veyances owned or leased by the taxpayer unless

it is established by the taxpayer that the price

charged by the controlling or controlled person

for such transportation constitutes an arm’s-

length charge (under the standard described in

paragraph (b)(1) of §1.482-1). The term

“purchased transportation to the customer” in-

cludes transportation to a warehouse, terminal,

or distribution facility owned or operated by the

taxpayer, provided that such transportation is

performed under the conditions described in the

first sentence of this subdivision. The taxpayer

must demonstrate the nonprofit character of the

transportation services, as described in (c) of

this subdivision, in light of all the facts and cir-

cumstances. It shall be presumed that the re-

quirements set forth in either (a) or (c) of this

subdivision (relating, respectively, to conveyance

ownership and profits) are not satisfied if the

taxpayer requires customers to purchase min-

erals or mineral products only on a delivered

basis, by failing to offer such minerals or prod-

ucts for sale on the basis of a price f.o.b. the

taxpayer’s mine or plant, or by other means. In

the case of taxpayers computing gross income

from mining under the provisions of paragraph

(d) of this section, the term “purchased trans-

portation to the customer” refers to transporta-

tion which conforms with the other requirements

of this subdivision and which is performed to

32a

transport the taxpayer’s first marketable product

or group of products (as defined in paragraph

(d) (1) (iv) of this section) rather than to trans-

port minerals or mineral products which do not

yet constitute the taxpayer’s first marketable

product or group of products.

* * * * *

(g) Nonmining processes—* * *

* * * * *

(3) Transportation for the purpose of mar-

keting or distribution; storage. Transportation

the primary purpose of which is marketing, dis-

tribution, or delivery for the application of only

nonmining processes shall not be considered as

mining. Nor shall transportation be con-

sidered as mining merely because, during the

course of such transportation, some extraneous

matter is removed from the ore or mineral by

the operation of forces of nature, such as evapo-

ration, drainage, or gravity flow. Similarly,

storage or warehousing of manufactured prod-

ucts shall not be considered as mining. The pre-

ceding sentence shall apply even though, during

the course of such storage or warehousing, some

extraneous matter is removed from the ore or

mineral by the operation of forces of nature,

such as evaporation, drainage, or gravity flow.

* * * * *

§ 1.613-4 Gross income from the property in the

case of minerals other than oil and gas.

* * * * *

33a

(d) Cases where a representative market or

field price cannot be ascertained—* * *

(3) Treatment of particular items in com-

puting gross income from the mining by use

of methods based on the taxpayer's costs. (i)

Except as specifically provided elsewhere in this

section, when determining gross income from

mining by use of methods based on the tax-

payer’s costs, the costs attributable to mining

transportation shall be treated as mining costs,

and the costs attributable to nonmining trans-

portation shall be treated as nonmining costs.

Accordingly, except as specifically provided else-

where in this section, all profits attributable to

mining transportation shall be treated as mining

profits, and all profits attributable to nonmining

transportation shall be treated as nonmining

profits. For this purpose, mining transportation

means so much of the transportation of ores or

minerals (whether or not by common carrier)

from the point of extraction from the ground to

plants or mills in which other mining processes

are applied thereto as is not in excess of 50 miles

or, if the taxpayer files an application pursuant

to paragraph (h) of this section and the Com-

missioner finds that both the physical and other

requirements are such that the ores or minerals

must be transported a greater distance to such

plants or mills, the transportation over the

greater distance. Further, for this purpose, non-

mining transportation includes the transporta-

tion (whether or not by common carrier) of

ores, minerals, or the products produced there-

- —

84a

from, from the point of extraction from the

ground to nonmining facilities, or from a mining

facility to a nonmining facility, or from one

nonmining facility to another, or from a non-

mining facility to the customers who purchase

the taxpayer’s first marketable product or group

of products. See paragraph (e)(2) of this sec-

tion for provisions relating to purchased trans-

portation to the customer and paragraph (g) (8)

of this section for provisions relating to trans-

portation the primary purpose of which is mar-

keting or distribution. In the absence of other

methods which clearly reflect the costs of the

various phases of transportation, the cost at-

tributable to nonmining transportation shall be

an amount which is in the same ratio to the

costs incurred for the total transportation as

the distance of the nonmining transportation is

to the distance of the total transportation. As

an example, where the plants or mills in which

mining processes are applied to ores or minerals

are in excess of 50 miles from the point of ex-

traction from the ground (or in excess of a

greater distance approved by the Commis-

sioner), the costs incurred for transportation to

those plants or mills in excess of 50 miles (or

of that greater distance) shall be treated as

nonmining costs in determining gross income

from mining. Accordingly, all profits attribut-

able to that excess transportation are treated as

nonmining profits. However, except in the case

of transportation performed in conveyances

owned or leased by the taxpayer, the preceding

85a

sentence shall apply only to taxable years be-

ginning after November 30, 1968.

* * * * *

(iii) In determining gross income from min-

ing by use of methods based on the taxpayer’s

costs—

(a) The costs attributable to containers, bags,

packages, pallets, and similar items as well as

the costs of materials and labor attributable to

bagging, packaging, palletizing, or similar op-

erations shall be considered as nonmining costs.

(b) The costs attributable to the bulk loading

of manufactured products shall be considered as

nonmining costs.

warehouses or distribution terminals for manu-

factured products shall be considered as non-

mining costs.

Accordingly, all profits attributable thereto are

treated as nonmining profits.

(iv) In computing gross income from mining

by the use of methods based on the taxpayer’s

costs, the principles set forth in paragraph (c)

of §1.613-5 shall apply when determining

whether selling expenses and trade association

dues are to be treated, in whole or in part, as

mining costs or as nonmining costs. To the ex-

tent that selling expenses and trade association

dues are treated as nonmining costs, all profits

attributable thereto are treated as nonmining

profits.

¢ + * * + *

(4) Proportionate profits method. (i) The

objective of the “proportionate profits method”

86a

of computation is to ascertain gross income from

mining by applying the principle that each dol-

lar of the total costs paid or incurred to produce,

sell, and transport the first marketable product

or group of products (as defined in subdivision

(iv) of this subparagraph) earns the same per-

centage of profit. Accordingly, in the propor-

tionate profits method no ranking of costs is

permissible which results in excluding or minim-

izing the effect of any costs incurred to produce,

sell, and transport the first marketable product

or group of products. For purposes of this sub-

paragraph, members of a controlled group shall

be treated as divisions of a single taxpayer. See

paragraph (j) of this section for the definitions

of the terms “controlled” and “group.”

(ii) The proportionate profits method of com-

putation is applied by multiplying the taxpayer’s

gross sales (actual or constructive) of his first

marketable product or group of products (after

making the adjustments required by paragraph

(e) of this section) by a fraction whose numer-

ator is the sum of all the costs allocable to those

mining processes which are applied to produce,

sell, and transport the first marketable product

or group of products, and whose denominator is

the total of all the mining and nonmining costs

paid or incurred to produce, sell, and transport

the first marketable product or group of prod-

ucts (after making the adjustments required by

this paragraph and paragraph (e) of this sec-

tion). The method as described herein is merely

a restatement of the method formerly set forth

in the second sentence of Regulations 118, sec-

tion 39.23(m)-1 (e) (8) (1989 Code). The pro-

37a

portionate profits method of computation may

be illustrated by the following equation:

Mining Costs yey ee

Total Costs

= Gross Income from Mining.

(iii) Those costs which are paid or incurred

by the taxpayer to produce, sell, and transport

the first marketable product or group of prod-

ucts, and which are not directly identifiable with

either a particular mining process or a particu-

lar nonmining process shall, in the absence of a

specific provision of this section providing an

apportionment method, be apportioned to min-

ing and to nonmining by use of a method which

is reasonable under the circumstances. One

method which may be reasonable in a particular

case is an allocation based on the proportion that

the direct costs of mining processes and the di-

rect costs of nonmining processes bear to each

other. For example, the salary of a corporate

officer engaged in overseeing all of the tax-

payer’s processes is an expense which may rea-

sonably be apportioned on the basis of the ratio

between the direct costs of mining and nonmin-

ing processes. On the other hand, an expense

such as workmen’s compensation premiums

would normally be apportioned on the basis of

direct labor costs. For the rule relating to sell-

ing expenses, see paragraph (c) (4) of § 1.613-5.

(iv) As used in this section, the term “first

marketable product or group of products” means

the product (or group of essentially the same

products) produced by the taxpayer as a result

38a

of the application of nonmining processes, in the

form or condition in which such product or prod-

ucts are first marketed in significant quantities

by the taxpayer or by others in the taxpayer’s

marketing areas. For this purpose, bulk and

packaged products are considered to be essen-

tially the same product. Sales between members

of a controlled group (as defined in paragraph

(j) of this section) shall not be considered in

making a determination under this subdivision.

The first marketable product or group of prod-

ucts does not include any product which results

from additional manufacturing or other non-

mining processes applied to the product or prod-

ucts first marketed in significant quantities by

the taxpayer or others in the taxpayer’s market-

ing area. For example, if a cement manufac-

turer sells his own finished cement in bulk and

bags and also sells concrete blocks or dry ready-

mix aggregates containing additives, the finished

cement in bulk and bags, constitutes the first

marketable product or group of products pro-

duced by him. Similarly, if an integrated iron

ore and steel producer sells both pig iron in

various sizes and rolled sheet iron or shapes,

his first marketable product is the pig iron in

its various sizes. Further, if an integrated clay

and brick producer sells both unglazed bricks

and tiles of various shapes and sizes and addi-

tionally manufactured bricks and tiles which are

specially glazed, the unglazed products, both

packaged and unpackaged, constitute his first

marketable product or group of products.

(v) (a) As used in this subparagraph, the

term “gross sales (actual or constructive)”

39a

means the total of the taxpayer’s actual competi-

tive sales to others of the first marketable prod-

uct or group of products, plus the taxpayer’s

constructive sales of the first marketable product

or group of products used or retained for use

in his own subsequent operations, subject to the

adjustments required by paragraph (e) of this

section. See (b) of this subdivision in the case

of actual sales between members of controlled

groups and in the case of constructive sales. A

“constructive sale” occurs when a miner-manu-

facturer is deemed, for percentage depletion pur-

poses, to be selling the first marketable product

or group of products to himself.

(b) In the case of sales between members of

a controlled group as to which the district direc-

tor has exercised his authority under section

482 and the regulations thereunder and has de-

termined the appropriate price with respect to

specific sales transactions, that price shall be

deemed, for those transactions, to be the actual

amount for which the first marketable product

or group of products is sold for purposes of this

subdivision (v). In the case of all other sales

between members of a controlled group, and in

the case of constructive sales, the prices for such

sales shall be determined by use of the principles

set forth in paragraph (c) of this section, sub-

ject to the adjustments required by paragraph

(e) of this section. In the case of constructive

sales, see paragraph (c)(4) of this section for

rules relating to information to be furnished by

the taxpayer.

* * * * x

40a

(e) Reductions of sales price in computing

gross income from mining—* * *

* * * * *

(2) Purchased transportation to the cus-

tomer. * * *

# * * * * .

(ii) If a taxpayer computes gross income

from mining under the provisions of paragraph

(d) of this section, the cost of purchased trans-

portation to the customer (as defined in subdivi-

sion (ili) of this subparagraph) shall be ex-

cluded from the gross sales of his first market-

able product or group of products (after any

adjustments required by subparagraph (1) of

this paragraph), and from the denominator of

the proportionate profits fraction, so as not to

attribute profits to the cost of that transporta-

tion. Similar transportation cost adjustments

may be made, if appropriate, in the case of other

methods of computation which are based on the

taxpayer’s costs. For the treatment of costs and

profits attributable to transportation which is

not purchased transportation to the customer as

defined in subdivision (iii) of this subparagraph,

see paragraph (d)(3)(i) of this section.

(iii) For purposes of this section, the term

“purchased transportation to the customer”

means, in general, nonmining transportation of

the taxpayer’s minerals or mineral products to

the customer—

(a) Which is not performed in conveyances

owned or leased directly or indirectly, in whole

or in part, by the taxpayer.

(b) Which is performed solely to deliver the

taxpayer’s minerals or mineral products to the

4la

customer, rather than to transport such minerals

er products for packaging or other additional

processing by the taxpayer (other than inci-

dential storage or handling), and

narily does not earn any profit.

For purposes of the preceding sentence, trans-

portation which is performed by a person con-

trolling or controlled by the taxpayer (within

the meaning of paragraph (j)(1) of this sec-

tion) shall be deemed to have been performed

in conveyances owned or leased by the taxpayer

unless it is established by the taxpayer that the

price charged by the controlling or controlled

person for such transportation constitutes an

arm’s-length charge (under the standard de-

scribed in paragraph (b) (1) of § 1.482-1). The

term “purchased transportation to the customer”

includes transportation to a warehouse, terminal,

or distribution facility owned or operated by the

taxpayer, provided that such transportation is

performed under the conditions described in the

first sentence of this subdivision. A taxpayer

will not be deemed ordinarily to earn a profit

on transportation merely because charges for the

transportation are included in the stated selling

price, rather than being separately stated or

segregated from other billing. A taxpayer will

not be deemed ordinarily to earn a profit on

transportation if the rates for the transporta-

tion constitute an arm’s-length charge ordinarily

paid by shippers of the same product in similar

circumstances. If a taxpayer computes gross in-

come from mining under the provisions of para-

graph (d) of this section, the term “purchased

42a

transportation to the customer” refers to trans-

portation which conforms to the other require-

ments of this subdivision and which is performed

to transport the taxpayer’s first marketable

product or group of products (as defined in para-

graph (d) (4) (iv) of this section) rather than

to transport minerals or mineral products which

do not yet constitute the taxpayer’s first market-

able product or group of products.

* * * * *

(g) Nonmining processes—* * *

* * * * *

(3) Transportation for the purpose of mar-

keting or distribution; storage. Transportation

the primary purpose of which is marketing, dis-

tribution, or delivery for the application of only

nonmining processes shall not be considered as

mining. Nor shall transportation be considered

as mining merely because, during the course of

such transportation, some extraneous matter is

removed from the ore or mineral by the opera-

tion of forces of nature, such as evaporation,

drainage, or gravity flow. Similarly, storage or

warehousing of manufactured products shall not

be considered as mining. The preceding sentence

shall apply even though, during the course of

such storage or warehousing, some extraneous

matter is removed from the ore or mineral by

the operation of forces of nature, such as evapo-

ration, drainage, or gravity flow.

(4) Manufacturing, etc. The _ production,

packaging, distribution, and marketing of manu-

43a

factured products, and the processes necessary

or incidental thereto, are nonmining processes.

* 1% * * *

§ 1.613-5 Taxable income from the property.

* * * * *

ing taxable income from the property. * * *

* * * « *

Be attiel bag

* * * * *

(ii) A reasonable portion of the expenses of

selling a refined, manufactured, or fabricated

product shall be subtracted from gross income

from the property. Such reasonable portion shall

be equivalent to the typical selling expenses

which are incurred by unintegrated miners or

producers in the same mineral industry so as to

maintain equality in the tax treatment of unin-

tegrated miners or producers in comparison with

integrated miner-manufacturers or producer-

manufacturers. If unintegrated miners or pro-

ducers in the same mineral industry do not typi-

cally incur any selling expenses, then no portion

of the expenses of selling a refined, manufac-

tured, or fabricated product shall be subtracted

from gross income from the property when de-

termining the taxpayer’s taxable income from

the property.

wv U. S&S. GOVERNMENT PRINTING OFFICE; 1980 320238 310

This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.