# Petition for Writ of Certiorari — Rhoades Oil Co. v. United States > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40386013_1452%3A1 ## Record - **Collection:** Supreme Court brief - **Document type:** Petition for Writ of Certiorari - **Published:** January 1, 1998 - **Citation:** 522 U.S. 1045 ## Text soa ee } i vee ol 1 SEP 1 7 1997 —BFHCE Ob tHe CL eR N IN THE SUPREME COURT OF THE UNITED STATES OCTOBER TERM 1997 RHOADES OIL COMPANY Petitioner, THE UNITED STATES OF AMERICA Respondent. PETITION FOR A WRIT OF CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE TENTH CIRCUIT JOHN B. TURNER * CHARLES GREENOUGH STUART, BIOLCHINI, TURNER & GIVRAY 3300 First Place Tower Tulsa, Oklahoma 74103 (918) 582-3311 *Counsel of Record September 17, 1997 Attorneys for Petitioner ry QUESTION PRESENTED Did the Tenth Circuit Court of Appeals violate this Court’s rulings, reaffirmed most recently in Commissioner v. Schleier, 115 S.Ct. 2159 (1995) and United States v. Burke, 112 S.Ct. 1867 (1992), that exclusions from gross income are available only if specifically stated and that such exclusions must be narrowly construed, when the Tenth Circuit ruled that the lifting costs of an oil and gas business are excluded from its gross income because such lifting costs are analogous to costs of goods sold which are excluded from the gross income of a manufacturing, merchandising, or mining business under 26 C.F.R. §1.61-3(a)? -ii- LIST OF PARTIES Petitioner and Respondent are named in the caption and were the only parties to this case before both the Tenth Circuit Court of Appeals and the United States District Court for the Northern District of Oklahoma. RULE 29.6 STATEMENT As required by Rule 29.6 of this Court, Petitioner, which is a Delaware corporation, states that it has no parent company or nonwholly owned subsidiaries. -lll- TABLE OF CONTENTS Page oo se 8 8 | | gy. sR ene eae re i ee ie li WIRD Oe RPA AMEET EE 5 bw ce ce wh es il RO GERLS vk o e es ili RPM PE PPADS ks oc ee es v Se ME ee ee le 2 NN gs eee si ye 2 STATUTES AND REGULATIONS .......... 3 -jV- TABLE OF CONTENTS (continued) REASONS FOR GRANTING CERTIORARI .... 6 The Tenth Circuit’s opinion broadly construing the exclusion from _ gross income contained at 26 C.F.R. §1.61-3(a) to apply by analogy to the lifting costs of an oil and gas business violates a line of cases from this Court that began over forty years ago with Jacobson and Glenshaw Glass and has continued to the recent decisions in Schleier and Burke, all of which consistently and uniformly hold that the only exclusions from gross income are those which are specifically stated, and that those exclusions which are specifically stated must be narrowly CI ss Oe ee a es 8 RELIEF REQUESTED AND CONCLUSION ... 18 ATER 6 ea eee Er Oe es es A-1 Yo TABLE OF AUTHORITIES CASES Commissioner v. Glenshaw Glass Co., Wot iP EAM ek ee eae ok passim Commissioner v. Jacobson, GF Bite. cae, OP we es passim Commissioner v. Schleier, ERD Ok Rt 8 ee passim Laguna Royalty Co. v. Commissioner, 27 T.C.M. (CCH) 164 (1968), aff'd 406 F.2d 703 (Sth Cir. 1969) ...... iz, 13 Max Sobel Wholesale Liquors v. Commissioner, 630 F.2d 670, 673-4 (9th Cir. 1980) ........ 14 All-Steel Equipment, Inc. v. Commissioner, 54 T.C. 1749, 1751 (1970), aff'd in part and rev'd in part on the grounds, 467 F.2d 1184 FR Ee ia ee ee ee 17 O’Gilvie v. United States, eit ve Oe 2 eee 7 United States v. Burke, BER ee TO OEE ooo eee ek passim United States v. Centennial Savings Bank, BES Wie Sot ROAR CEE ke ek ce ig 11 is ce ee eee reer III I -vi- TABLE OF AUTHORITIES (continued) STATUTES Paes Wt ORE a iW a's me a kk we ele 9 ee Rea Ok a a ln ee eS oe wee es 13 Be es OER ok es PR eee 17 Se Shan Ek Ase WS Peo ae 4 eS a ak EER Oe Rees 3, 15 OR PER a oe oe OR YS eR oe eS 16 REGULATIONS BSS EE 6 a We Ek Cw eee en 10 ce ee ED os gk x ak ee passim Ee Ge a RE. VN aOR TS OG en 17 ee as SE 6 eck be eee ReeD 18 Se ee Oa» oN oS en OR 16 aes enn, ©) oo 6 6 eS ELAS 16 PT BOO i Pe CERES Cee Oe 16 -Vii- TABLE OF AUTHORITIES (continued) SUPREME COURT RULES pene Sc ONEt Meltre £0, AO) gc oc ee we es 7 I UE EE ekg ws ce eke ow ews 2 PT GE UO A of Se ek hk ae ee ll IN THE SUPREME COURT OF THE UNITED STATES OCTOBER TERM 1997 RHOADES OIL COMPANY Petitioner, THE UNITED STATES OF AMERICA Respondent. PETITION FOR A WRIT OF CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE TENTH CIRCUIT Rhoades Oil Company ("Petitioner") asks this Court for writ of certiorari to review the June 19, 1997, Order and Judgment of the United States Court of Appeals for the Tenth Circuit. .% OPINIONS BELOW The Tenth Circuit’s opinion below is an unreported Order and Judgment filed on June 19, 1997. A-1.' In that opinion, the Tenth Circuit reversed an Order of the United States District Court for the Northern District of Oklahoma filed February 15, 1996. A-4. The District Court had granted summary judgment to Petitioner in a suit for refund to recover personal holding company taxes and interest assessed against and paid by Petitioner for the tax years 1988, 1989, and 1990. Pursuant to the February 15, 1996 Order, Judgment was entered in favor of Petitioner and against Respondent in the District Court on February 20, 1996. A-26. JURISDICTION The Tenth Circuit Court of Appeals filed its Order and Judgment on June 19, 1997. A-1. Jurisdiction lies under 28 U.S.C. § 1254(1) for this Court to review the final decision of the Tenth Circuit Court of Appeals. This Petition for Certiorari is filed under Rule 13.1 of this Court. 'The Appendix to this petition is cited as "A- pm STATUTES AND REGULATIONS This case involves the following statutes and regulations, all of the relevant portions of which are fully reprinted in the Appendix due to their length: Statutes - 26 U.S.C. §§ 61(a)(2), 162, 471, 542(a), 543, and 613; Regulations - 26 C.F.R. §§ 1.61-1(a), 1.61-3(a), 1.471- 7, 1.471-8, 1.613-3, 1.613-4(a) and (f), and 1.614-3(e). STATEMENT OF THE CASE This case concerns the amount of gross income of an oil and gas business. This case is unusual in that the usual roles of the taxpayer (Petitioner) and the government (Respondent) are reversed: Petitioner asks this Court to determine that its gross income is higher, while Respondent seeks a ruling that Petitioner’s gross income is lower. This is due to the fact that this case involves personal holding company taxes, which are assessed when a taxpayer’s "personal holding company income" exceeds sixty percent of its "adjusted ordinary gross income." 26 U.S.C. §543(a). sil Respondent calculated Petitioner’s gross income” by excluding Petitioner’s "lifting costs," which are the costs of labor, repair, maintenance, materials, supplies, property taxes, insurance, and severance taxes incurred to operate and maintain oil and gas wells.’ Using the calculation of gross income put forth by Respondent, Petitioner met the test under 26 U.S.C. §542(a)(1) and was assessed personal holding company taxes. sie dal anal Math 18) rere Petitioner disputed Respondent’s calculation of its gross income, and _ unsuccessfully appealed the assessment under the Respondent’s internal procedures. Petitioner then paid the taxes and filed suit for a refund ___in the United States District Court for the Northern District of Oklahoma. Jurisdiction in the court of first instance was pursuant to 28 U.S.C. §1346(a)(1). The matter was submitted to the District Court on cross motions for summary judgment based on stipulated facts and upon the deposition testimony of one expert witness sponsored by Petitioner. Petitioner’s expert witness testified that an oil and gas business such as 1 le aa Ma EN ida ca bah *Gross income is the starting point for the determination of a taxpayer’s "adjusted ordinary gross income." 26 U.S.C. §543(b)(1). ‘Lifting costs are also sometimes referred to as "lease operating expenses." The terms are synonymous. -5- Petitioner does not have "costs of goods sold" and that Petitioner’s lifting costs were not the same as or comparable to costs of goods sold. This evidence was not rebutted by Respondent. A-69 . The sole issue presented to the District Court was whether lifting costs should be excluded from Petitioner’s gross income in determining if Petitioner was subject to personal holding company taxes. The District Court ruled in favor of Petitioner, rejecting the argument of Respondent that 26 C.F.R. § 1.61-3(a) applied. A-4. The District Court held that 26 C.F.R. §1.61-3 on its face applies only to a "manufacturing, merchandising, or mining business" and that the Petitioner is an oil and gas business. The District Court noted that the oil and gas business is not within the meaning of "mining" under the Internal Revenue Code. The District Court ruled that because there is no statutory or regulatory exclusion from gross income for the lifting costs of an oil and gas business, Petitioner’s gross income must be calculated without such an exclusion. With Petitioner’s gross income calculated without the exclusion of lifting costs, Petitioner was not subject to personal holding company taxes, and was entitled to a refund of the taxes paid. The Tenth Circuit Court of Appeals reversed the District Court, stating that it was "persuaded that lifting costs are analogous to costs of goods sold" and that a. therefore the reasoning of 26 C.F.R. §1.61-3(a) applied. A-2. The Tenth Circuit stated that "the general rule is that "“gross income’ means the total sales less the costs of goods sold[,]" and then implied that 26 C.F.R. §1.61- 3(a) merely applied this general definition to manufacturing, merchandising, or mining businesses. A- 2. However, the Tenth Circuit cited no authority for the "general rule" on which it relied. REASON FOR GRANTING CERTIORARI This Court should grant certiorari because the decision of Tenth Circuit Court of Appeals violates the long line of cases in which this Court has consistently held that an item is included in gross income unless there is a specific exclusion available, and that all such exclusions from gross income must be narrowly construed. Commissioner v. Schleier, 115 S.Ct. 2159, 2163 (1995); United States v. Burke, 112 S.Ct. 1867, 1870, 1878 (SOUTER, J. Concurring at 1878) (1992); Commissioner v. Glenshaw Glass Co., 75 S.Ct. 483, 475, 477-78 (1955); Commissioner v. Jacobson, 69 S.Ct. 358, 369 (1949). Instead, the Tenth Circuit broadly construed the exclusion from the gross income of a manufacturing, mining, or merchandising business for costs of goods sold, contained at 26 C.F.R. § 1.61- 3(a), to apply by analogy to exclude the lifting costs of an oil and gas business from its gross income. There is no specific exclusion stated anywhere in the Internal 7. a Revenue Code or the Internal Revenue Regulations that requires the exclusion of lifting costs from the gross income of an oil and gas business. The Tenth Circuit opinion decided this federal question in a way that is in conflict with applicable decisions of this Court. See, S. Ct. Rule 10.1(c). The writ of certiorari is needed to safeguard the integrity of this Court’s holdings that the only exclusions from gross income available are those that are specifically stated, and that the exclusions that are available must be narrowly construed. This Court has repeatedly emphasized these principles in a line of cases that spans over forty years, including the Jacobson case in 1949 and the Glenshaw Glass case in 1955. The Respondent has successfully argued before this Court on three occasions in the last five years that exclusions from gross income must be narrowly construed. O’Gilvie v. United States, 117 S.Ct. 452 (1996); Schleier; Burke. However, in this case, the United States instead convinced the Tenth Circuit to broadly construe 26 C.F.R. §1.61-3(a) to exclude lifting costs from Petitioner’s gross income. The United States did so only because a broad construction of the exclusion happened to result in higher taxes for Petitioner in this case, due to the unusual nature of personal holding company taxes. The United States is bound by this Court’s holdings on the required specificity and narrow scope of exclusions from gross income, even in the unusual case such as this -8- one in which the application of the rule results in lower taxes. The Tenth Circuit’s opinion is in irreconcilable conflict with this Court’s decisions in Glenshaw Glass, Jacobson, Schleier, and Burke. Only certiorari relief from this Court will correct the wrong that has been committed. The Tenth Circuit’s opinion broadly construing the exclusion from gross income contained at 26 C.F.R. §1.61-3(a) to apply by analogy to the lifting costs of an oil and gas business violates a line of cases from this Court that began over forty years ago with Jacobson and Glenshaw Glass and has continued to the recent decisions in Schleier and Burke, all of which consistently and uniformly hold that the only exclusions from gross income are those which are specifically stated, and that those exclusions which are specifically stated must be narrowly construed. The error committed by the Tenth Circuit is simple. In direct violation of the fundamental principles laid down by this Court governing the availability and construction of exclusions from gross income, the Tenth Circuit broadly construed 26 C.F.R. §1.61-3(a) to apply by analogy to exclude the lifting costs of an oil and gas ot Aion catches aaa cali -9- business from its gross income. The plain language of 26 C.F.R. §1.61-3(a) defines the gross income of a "manufacturing, merchandising, or mining business" as "total sales less the cost of goods sold[.]". The Tenth Circuit extended the regulation to apply to the lifting costs of an oil and gas business. In doing so, the Tenth Circuit narrowly construed the definition of gross income under 26 U.S.C. §61 and broadly construed the exclusion from gross income contained in 26 C.F.R. §1.61-3(a), in direct conflict with Glenshaw Glass, Schleier, and Burke. The result is a new exclusion from gross income which is not specifically stated in the Internal Revenue Code or Regulations, in violation of Jacobson. The definition of gross income under the Internal Revenue Code is found at 26 U.S.C. §61(a)(2): "(a) GENERAL DEFINITION.-- Except as otherwise provided in this subtitle, gross income means all income from whatever source derived, including, but not limited to, the following items: (2) Gross income derived from business|[.]}" -10- Although renumbered, this statute has been essentially unchanged since well before the Jacobson and Glenshaw Glass cases. In Glenshaw Glass, this Court held that the definition of gross income under the Internal Revenue Code has a "sweeping scope" intended to bring the taxing power to bear on all constitutionally taxable receipts. 75 S.Ct. at 475, 477-8. Since that time, this Court has "repeatedly emphasized" the sweeping scope of the definition of gross income under the Internal Revenue Code. Schleier, 115 S.Ct. at 2163; Burke, 112 S.Ct. at 1870. This Court has "also emphasized the corollary to §61(a)’s broad construction, namely the ‘default rule of statutory construction that exclusions from income must be narrowly construed.’"Schleier, 115 S.Ct. at 2163, quoting Burke, 112 S.Ct. at 1878 (SOUTER, J., concurring). The rule is also emphasized in the 26 C.F.P. §1.61-1(a), issued by the Internal Revenue Service under 26 U.S.C. §61(a), which provides that: "Gross income means all income from whatever source derived, unless excluded by law." O > > In your expert opinion for companies that are involved solely in oil and gas exploration, do generally accepted accounting principles require classification of any costs as costs of goods sold? No, they do not. No issued financial accounting standard requires that? No. That terminology has not been used as a cost description, if you will, in FAS 19 or 69. Is that classification used in customary industry practice? For companies involved exclusively in exploration and production? O>f OO} > QO > -A-72- Correct. No, it is not. For companies that are involved exclusively in oil and gas exploration, does FAS 19 specify a classification of the cost to operate and maintain wells and related equipment and to the other costs of operating and maintaining wells? Yes, it does. And what is that? Operating expenses or lease operation expenses. Does that classification include labor costs, repairs, maintenance, materials, supplies and fuels consumed, supplies utilized in operating wells, property taxes, insurance and severance taxes? Yes, it does. So all of those items would be classified as production costs or lease operating expenses under generally accepted accounting principles? Yes, they are. Those terms are used interchangeably. What is the reason behind that classification of costs? MR. GRIGORIAN: | Even though we’re reserving objections, I would just like to state an objection to any testimony relating to reasoning behind the GAAP principles unless he’s shown to have been involved in their promulgation and would know, or establish a foundation for where -- for why he knows what the reasons are. (by Mr. Greenough) Based on your -- let me rephrase this question please. Based on your experience in the industry, do you have a belief as to the reason behind the classification that we just discussed? > O > > — -A-73- Yes, I do. And what is that? That’s the industry terminology for those classes of costs. The accounting followed what was standard terminology in the industry as related to those expenses. For a company that’s involved exclusively in oil an gas exploration and not in the business of refinery or chemically altering oil and gas products, is a classification of the items of costs we just discussed as costs of goods sold generally appropriate under generally acceptable accounting principles? Would it be generally appropriate to call those costs cost of goods sold: Correct. No. CROSS-EXAMINATION BY MR. GRIGORIAN: [PAGE 26, LINE 17] So your opinion regarding the use of cost of goods sold in the oil and gas industry was that it would be an inappropriate form of classification on an income statement or a statement of operations. Is that what you stated earlier? That’s correct. Q -A-74- Q When you refer -- when you use the term “inappropriate,” what -- is it about the use of the phrase “cost of goods sold" that you find inappropriate? A It’s not descriptive in that it doesn’t convey what the nature of those costs are. The nature of those costs are not cost of goods sold. [PAGE 40, LINE 11] Q I asked you earlier about trying to compare what a lifting cost is in an oil and gas company to what cost of goods sold are in a manufacturing process, and I believe it was your testimony that you can’t compare them because, for one reason, you would incur lifting costs whether or not you sold any oil and gas; is that true? Is that one of the -- A That’s one of the reasons. Q Okay. Let me ask you, are there elements of cost of goods -- is there an element of cost of goods sold, whether or not you call it a cost of goods sold, but an expense incurred by the corporation which is contained in the cost of goods sold figure, but which would have otherwise been incurred whether or not the corporation, the manufacturing corporation, sold anything? MR. GREENOUGH: I’ll object as to vague. I don’t understand that question at all. (2) > > © >OP> fA -A-75- (By Mr. Grigorian) Mr. Downs, do you understand the question? | Not really, but I think I’ve already answered that question once. Okay. I think you are asking it a different way, but a moment ago you asked me is there any -- if I took the scenario of -- if I would agree that lifting costs were somehow similar to cost of goods sold except they are called that by industry practice, and the answer is no. Lifting costs are a period cost for the operation of a property which would be incurred regardless of the level of production, regardless of the level of sales, and regardless of the level of revenues. Cost of goods sold are the assigned costs of the inventory a company sold during the period, and there’s no relationship between the two. I understand that, but can you tell me what goes into a cost of goods sold? For a manufacturing company? Yes. Well, why don’t you ask me what goes into the cost of inventory because what goes into the cost of goods sold is merely an allocation of the inventory costs for the products you sold in a period. What goes into the cost of inventory depends upon your flow-of-cost assumption as to what accounting method you want to use, but it would include, in a manufacturing environment, direct labor, raw materials, supplies, and overhead, including depreciation. If you didn’t sell anything, you wouldn’t have -A-76- any cost of goods sold that period. It would be zero. What you sell is merely an allocation of what you’ve accumulated as your inventory costs. Lifting costs, on the other hand, they don’t have any bearing to the level of sales. It’s the costs you incur in the period to operate and maintain that property, which might include an allocation of support facilities for a group of properties which you would incur. Whether you produced and sold one barrel or a million barrels, you are going to incur some of those costs. That is a major difference, in my opinion. Okay. The costs of inventory that you described as being elements of the cost of inventory, direct labor, overhead, supplies, cost of goods sold aside, are those expenses, would you agree, that are also often incurred regardless of whether or not the manufacturer sold any product? Irrespective of whether or not they are charged to expense and called cost of goods sold? There are costs -- there are costs in inventory for the cost of the products you manufactured during the period and prior periods. If you don’t sell any of those, you don’t incur any cost of goods sold. Now, if you didn’t manufacture anything either, you know, ignore the fact that you probably can only do that one year, but if you neither manufactured nor sold, there are costs that would show up as expenses in your financial statements, your statement of income. You’d have no revenues, you’d have no cost of goods sold. You could still have overhead, the administrative overhead called -A-77- general and administrative expenses. An oil company incurs general and administrative expenses, too, but in a manufacturing environment, the accounting rules and the tax rules would require you to capitalize a portion of those costs into inventory on an annual basis if you manufactured some products that period, but there’s a distinction there. One relates to the capitalization in the inventory if they were manufactured. Cost of goods sold relates to what was the cost you’ve incurred for the products you sold that period. That’s why it’s, you know, a very descriptive term for refining and marketing and chemical operations, very descriptive. [PAGE 45, LINE 4] /S/ JAMES M. DOWNS JAMES M. DOWNS Sworn to and subscribed before me this 19th day of May 1994. /S/ CHERYL M. RANK Notary Public My Commission expires Nov. 17, 1996 --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40386013_1452%3A1. Public record. Not legal advice.