The opinion of the court was delivered by: GRIM
The problem this tax case presents is one of defining 'gross income from mining' in determining the depletion allowance of an integrated miner-manufacturer of portland cement. Plaintiff seeks to recover certain income and excess profits taxes for the years 1951 through 1956. Being a miner of cement rock, plaintiff is entitled to a percentage depletion deduction from its income (10 per cent under the 1939 Revenue Code, 15 per cent under the 1954 Code.)
To make cement, plaintiff quarries its rock, crushes it to a small size, adds certain ingredients, burns the mixture in a kiln at intense heat, adds other ingredients and grinds the resulting mass into a fine powder, which is known as portland cement. It is agreed in this case that the finished portland cement is the first commercially marketable product in plaintiff's mining-manufacturing business.
There is an inherent difficulty in determining the base figure to which the depletion allowance is applied in a case, such as the present one, where a taxpayer uses the product of its own mining to manufacture finished cement. The difficulty arises from the fact that miners as such are entitled to a depletion allowance against their income tax liability while as manufacturers they are not so entitled. In an integrated situation, such as that in the present case, almost all processes relate at least to some extent to mining and, at the same time, they relate to some extent to manufacturing. Difficult as it may appear to be, for depletion purposes, a line must be drawn between what is to be considered mining and what is to be considered manufacturing.
In the Revenue Act of 1943 amending the 1939 Revenue Code, Congress attempted to resolve the miner-manufacturer problem by providing:
"(B) Definition of Gross Income From Property. -- As used in this paragraph the term 'gross income from the property' means the gross income from mining. The term 'mining', as used herein, shall be considered to include not merely the extraction of the ores or minerals from the ground but also the ordinary treatment processes normally applied by mine owners or operators in order to obtain the commercially marketable mineral product or products." 58 Stat. 21, 45 (1944).
The interpretation of this section was before the courts in a case involving the cement industry in Dragon Cement Co. v. United States, 244 F.2d 513 (1st Cir. 1957), cert. denied 355 U.S. 833, 78 S. Ct. 50, 2 L. Ed. 2d 45 (1957), and in other cases which followed it. It was decided in these cases that in the cement industry the base figure upon which to allow depletion under the 1943 Revenue Act was the gross income of each company, that is, the total of the sales of the finished product, cement, and that no attempt need by made to draw a line within the mining-manufacturing processes to find a base upon which to apply the depletion allowance.
By this 1960 amendment Congress apparently attempted to establish the market value of the cement rock at the point where it is to be fed into the kiln as the base for the application of the depletion allowance. However, since some integrated miner-manufacturers of portland cement such as plaintiff have no sales at the kiln feed processing stage, an arbitrary method had to be devised to determine the market value of the cement rock at this stage. This method is set forth in Treasury Regulation 118 which provides that
'* * * if the product is * * * processed (other than by the ordinary treatment processes * * *) '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 treatment processes actually applied * * *. If there is no such representative market or field price (as of the date of the 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 * * * minus the costs and proportionate profits attributable to * * * the processes beyond the ordinary treatment processes * * *.'
In view of the 1960 statutory definition of mining it must be concluded that this means that where there is no market value of a product until the finished stage (like the present case), the base for the application of the depletion allowance is the gross income, that is, the total market price of the finished portland cement
minus the costs and proportionate profits attributable to the processes beyond the kiln feed stage.
There is no direct evidence in the present case of the processing costs both prior to and after the kiln feed stage, but it has been stipulated that 'there is no disagreement between the parties as to the correctness of the basic costs used by the parties to make their computations'. In order to arrive at the proper depletion allowance in accordance with the above-quoted Treasury Regulation, the total gross income, that is, the total sales of the finished cement, must first be ascertained. Then there must be subtracted from this total gross income two things, (1) the total post-kiln feed costs and (2) the proportionate profits attributable to the processes beyond the kiln feed stage.
Computing the post-kiln feed costs should be a simple problem since from the stipulation it appears that there is no substantial disagreement between the parties as to the amount of these costs. The proportionate profits problem, however, is not so simple. My solution to this problem is to divide profits in the same proportion as are the costs. To do this the costs of all the processes, both the pre-kiln and post-kiln feed costs, must be totalled. The total post-kiln feed costs then must be ascertained. From these two figures a fraction must be created in which the total post-kiln feed costs will be the numerator and the total of all the costs, both pre-kiln and post-kiln, will be the denominator. Applying this fraction to the total gross profits the proportionate profits attributable to the proportionate the kiln feed stage will be ascertained. This post-kiln profit figure will then be added to the post-kiln cost figure and the total subtracted from the total gross income (total sales). The resulting figure will be the base figure to use to ascertain the proper depletion allowance. See United States v. Henderson Clay Products, 324 F.2d 7, 9 (5th Cir.1963), cert. denied 377 U.S. 917, 84 S. Ct. 1182, 12 L. Ed. 2d 186 (1964); Riddell v. California Portland Cement Co., 330 F.2d 16 (9th Cir.1964); Standard Lime and Cement Co. v. United States, 329 F.2d 939 (Ct. Claims, 1964).
In the present case there is a dispute over whether certain of plaintiff's processes shall be classified as pre-kiln feed or whether they shall be classified as post-kiln feed. These disputed processes are:
(1) The use of limestone, iron ore and sand purchased by plaintiff and blended with its own quarried cement rock to produce the required ...