JARECKI v. G. D. SEARLE & CO.
Legal provision: Internal Revenue Code
Argument of Wayne G. Barnett
Chief Justice Earl Warren: No. 151 John T. Jarecki, former collector of Internal Revenue, et al., Petitioners, versus G.D. Searle & Company.
Mr. Wayne G. Barnett: Mr. Chief Justice, may it please the Court.
This case and the Polaroid case which follows it, arise under the Excess Profits Tax Act of 1950, that's the so called Korean War excess profits tax.
The taxpayer is a corporation engaged in the development, manufacture and sale of ethical drugs.
During the years 1946 to 1949, before the excess profits tax years, the taxpayer developed two new chemical compounds, one of which proved to be effective in the treatment of peptic ulcers and was sold under the trade name of, “Banthine”.
The other was proved effective in the prevention and treatment of motion sickness and was sold under the name, “Dramamine”.
In 19 -- during the years 1950 to 1953, which are the excess profits tax years, the taxpayer realized very substantial amounts of income from the manufacture and sale of these two products.
It included that income in the computation of its excess profits tax for those years.
Later, however, they filed claims for refund, claiming that a part of that income in sale of those two products was entitled to relief in part from the excess profits tax under Section 456 of the Internal Revenue Code of 1939.
At the outset, I like to explain briefly what Section 456 really is.
Section 456 is one of a wide variety of provisions ultimately designed to provide a more equitable measure of the income that should be subjected to the special war time rate imposed by the excess profits tax.
Its particular profits is income which is realized during the excess profits tax years, but in fact is attributable to events or work done in prior years.
The clearest example might be income which was fully earned before the war, but was subject to litigation which was not resolved until after the excess profits tax was enacted.
And I think there is good reason not to subject that income to the full burden of the excess profits tax, simply because it wasn't really realized until that time.
Justice Charles E. Whittaker: (Inaudible)
Mr. Wayne G. Barnett: Yes.
I will come to the precise definition.
I'm -- at this point I was just suggesting the -- the general purpose of the provision.
There are three requirements to qualify for relief.
I'm speaking again in broad terms.
The first is you must have an eligible kind of income, income, an eligible class of income, income which is of a kind to which the section applied.
The second requirement is that it must -- that class, the eligible class of income, must be abnormal in amounts, which is defined to mean in excess of 115% of the average income of that same class for the four previous years.
Now, at this point, I think I can clarify Mr. Justice Whittaker's problem.
The statute in the definition of abnormal income first speaks of income which is abnormal in kind, income that is not normal for the taxpayer to receive and then speaks of income which is normal to receive, but which is abnormal in amount.
Now practically, it is only the abnormality in amount that is important because any income that is not normal to receive will also be abnormal in amount.
Such -- the -- the only real quantitative -- the only test that the abnormality test imposed is the quantitative test, but if you have income that is an eligible kind and which meets the quantitative test, then you have what is called abnormal income and the excess of that over the 115% average for the four or five years, less allocable deductions is the -- is called the net abnormal -- the net abnormal income.
Now you're not automatically entitled to relief for the net abnormal income.
The third step is that you must show that that income or part of it is in fact attributable to other years.
Now, if you satisfy all three of those tests, eligibility in kind, abnormality in amount and attributability to other years, then the relief that you get is that you reallocate the net abnormal income to the years to which it is attributable.
Now the significant part of the relief is the income that you reallocate to pre-excess profit tax years to prewar years, because any income that you cast back to those years, escapes the excess profits tax entirely.
Now, the problem here isn't all that complicated.
The problem in this case is concerned only with the threshold question, only with the question of the eligibility of the income, whether the income derived from the sale of these patented products, Dramamine and Banthine, which I omitted to say were patented, is income of the kind, which is eligible to qualify under the section.
Now eligibility is controlled by paragraph (1) and (2) of Section 456 (a) and all of my discussion will be about those two paragraphs and that is the one part --
Chief Justice Earl Warren: Can I ask this, thus if -- if the respondent gets over that first question, does he win?
Mr. Wayne G. Barnett: No, no.
This case --
Chief Justice Earl Warren: I thought you said, we were only --
Mr. Wayne G. Barnett: Yes.
Chief Justice Earl Warren: -- interested --
Mr. Wayne G. Barnett: The only question presented in this Court at this time is the question of eligibility.
Chief Justice Earl Warren: Yes.
Mr. Wayne G. Barnett: The other questions will still be in the case, but I -- I will find it later.
Chief Justice Earl Warren: But so far as this proceeding is concerned.
Mr. Wayne G. Barnett: Yes, in -- in the posture we're in, in this Court --
Chief Justice Earl Warren: You prevail --
Mr. Wayne G. Barnett: If we prevailed on that, we'd have to go back for trial in the other issues.
Chief Justice Earl Warren: Yes, yes.
Mr. Wayne G. Barnett: But the only question is --
Chief Justice Earl Warren: Yes, I understand.
Mr. Wayne G. Barnett: That is governed by paragraphs (1) and (2) of 456 (a), which is set forth at pages 24 and 25 of the appendix to our main brief, our big brief.
Now, paragraph (1) defines abnormal income as meaning income of any class described in paragraph (2).
That's the -- those are the eligible class of income, income of any class described in paragraph (2), so that the only eligible classes of income are those described in paragraph (2).
Paragraph (2), then lists four classes of income which are specifically described.
The one under which our taxpayer here claims to qualify is subparagraph (B), which includes income resulting from exploration, discovery or prospecting.
And his argument is that discovery as used there includes invention and therefore, its income derived from the sale of its invented products, Banthine and Dramamine, is income resulting from discovery i.e. the discovery of those two products.
Now I should add that there is an alternative argument which is made by the taxpayer here based on the last sentence of -- of paragraph (2).
That argument is made at greater length by Polaroid and in following case and I propose to deal with that primarily in that case and here, I would like to concentrate on the discovery argument.
The District Court entered summary judgment -- this is in a suit for refund by the taxpayer.
The total claim of refund, involve about 4.5 million dollars in tax.
Only three of the four years were actually covered by the suit.
The District Court granted summary judgment for the Government on the ground that discovery as used in subparagraph (B), does not include inventions.
The Court of Appeals for the Seventh Circuit reversed, holding that discovery was not used in the particular limited sense and could include inventions and remanded the case for trial to decide whether Dramamine and Banthine were actually discoveries though.
Now, subsequently, the Court of Appeals for the First Circuit in the Polaroid case expressly disagreed with the Seventh Circuit and First Circuit held the discovery was limited to the finding of mineral deposits and did not include inventions and it was to resolve that conflict that the cases were brought here.
Turning to the interpretation of subparagraph (B), what discovery there means, I would like -- I would like to concede at the outset that inventions are in common usage very often referred to as discoveries.
I'm not sure that it conforms with -- with the best use of the term.
I think the dictionary would support me that the best use of the term is to include finding things that previously exists, as distinguished from creating something new.
I don't want to quibble about that, how (Inaudible)
Justice Potter Stewart: Use the constitutional (Inaudible), doesn't it?
Mr. Wayne G. Barnett: Yes.
The Constitution also described --
Justice Potter Stewart: Did -- did you?
Mr. Wayne G. Barnett: Yes, it is indeed.
I think Webster's in fact, does distinguish between discovery and invention.
I -- I'm not relying on that distinction in any event.
I am prepared that the -- that customarily, very commonly, the inventions are called discoveries.
I would like to point out that so is virtually everything else in common usage and if you gave discovery the meaning in its broadest sense as -- as used, it would mean that virtually, all income results from discovery.
For example, not only does an inventor discover a new product, but a manufacturer discovers a new source of supply, he discovers a way to cut cost, he discovers a new market, he discovers the value of advertising.
In short, in common parlance, discovery really includes any new acquisition of knowledge and I -- I think it's clear that you can't read it in this statute in that broad sense.
Now, in fact taxpayers here, although that they state their argument as the common ordinary meaning versus a strict technical meaning, in fact they recognize that you -- the word has to be limited because although they start there, they end up trying to suggest that discovery really includes only basic inventions and doesn't include minor inventions, which certainly is not in accord with common usage.
So they also recognize that, we have to give the term here some -- some limited meaning and the question really is which limited meaning.
The Government's position is that discovery as used here in this statute is used in the well-defined and special sense in which it is used in mining.
Namely, this is one of the definitions included in the dictionary.
The original finding of a part of the vain or load, it has a fine requisite in valid location of a mining company.
So it's in the special use of discovery in the -- in industry that we contend is meaning here.
Now, I think I can prove -- I hope to prove simply from the face of the statutes, in the face of Section 456, that the term is used in that sense and does not include inventions.
Now first, our point to the subparagraph (B), which says income from exploration, discovery or prospecting, now, those three words are all words which have a special meaning in mining.
It is mining that is the common denominator among those three words.
The only -- the only way you can explain putting those three words together is the relationship to mining.
And if we assume that there's any cohesion within this single class of income, I think it has to be explained in terms of the relation to mineral products.
By the way, when I say mining, I'm including oil and gas, and the extracting industry.
The second evidence I think, is the -- if one interpreted discovery in -- in subparagraph (B) to include inventions, subparagraph (C), would be superfluous.
Subparagraph (C) defines is another and separate class of income, income from the sale of patent, formulae or processes.
Now, if income from the use of an invention or patent -- patents formulae and processes are ultimately all inventions and if income from the use of them in manufacturing the product were included in class B as income form discovery, a fortiori income from the sale of the invention itself would be included in class B as income from discovery and there would be nothing left for class C, subparagraph (C) to do.
That -- that's the rhetorical question asked by Judge Aldrich in -- in the Polaroid case, but if there is a big hole and it tends for the big cat, need there be a small hole for the small one?
Now third is that from the express inclusion as an eligible class, but income from the sale of inventions, it can be inferred that Congress intended to exclude income from the use of inventions.
That is nothing more than the inclusio unius, etcetera.
The -- and there is a -- a fourth consideration which drawn from the face statute of the homogeneity of the classes within themselves.
The importance of the classes is that you apply the quantitative test to each class separately, the 115% of the average test.
Now that means that all the items of income included within a particular class in the taxable year in order to decide whether their abnormal in amount, you compare them with all the items of income included -- belonging to that same class in prior years, even on the maybe different items of income.
Now, that comparison makes sense only if the items within a single class have something in common that -- that this homogeneity within the class.
Now, the inference I asked you to draw from that is this.
If Congress intended to make eligible income from the use of a patent, it would surely have included that income in the class with income from the sale of the patent (i.e. class C) and not in the class which the taxpayer contends was income from the sale of oil wells and goldmines, which is class B.
So from the face of the statute, I think that there are -- there is a great deal of evidence that discovery was here used in the -- in the mining sense.
Going beyond the statute, there's confirmation in -- elsewhere in the Internal Revenue Code itself, which where a discovery is used in provisions expressly limited to the mining industry, we set forth two of them in page 1 of our appendix Sections 105 and 114 (b) (2).
I will mention here only Section 105, because I think that is really the more important one.
That limits the income tax on gain from the sale of mineral properties if, but only if, the value of those properties was established, “By prospecting or exploration or discovery-work done by the taxpayer”.
Now that provision dates back to 1918.
It's been in the statute ever since then, with one very brief exception during the 1930s.
Though now, it's limited to gas and oil properties, it originally applied to all mineral properties.
The significance of that I'm -- don't like too much of it, but the significance is that those three words used together in combination, have been used together in companies for a long time in the patent statutes themselves, to refer to the mining industry.
Now that confirms that that is the common denominator and that is what explains the use of those three words together described as the single class of income.
Finally, what I think is really the most conclusive proof is the legislative history of -- of this particular provision itself.
Section 456 present here, was taken directly and in large part, verbatim from Section 721 of the Excess Profits Tax Act that was in effect during World War II and the only significant change in the paragraph (2) in two provisions was in the description of the classes of income now covered by subparagraphs (B) and (C).
Justice John M. Harlan: Is 721 pointed in your brief?
Mr. Wayne G. Barnett: Yes, it is.
But, I -- I think I can make the comparison easier for you if you will look at our reply brief at pages 10 and 11, there I -- I've set out the provision side by side as they appeared in the World War II law and the -- and the Korean War law at page 10 and 11 of the Government's reply brief which, is in numbers 151 and 159.
The -- you will see the first provision quoted is the provision that appeared in the World War II law as class C.
That included as knowledge per class of income, income resulting from exploration, discovery, prospecting, research or development of tangible property, patents, formulae or processes.
That provision expressly included the very kind of income that is involved in this case, income resulting from research and development of tangible property and also it included income resulting from patents by use as well as by sale.
So the income involved here would -- was expressly included in the World War II law.
Now, the changes and as I say, this is the only significant change made in this paragraph of the two provisions, that class was broken down into two classes which found -- which are now classes B and C and part of it was omitted.
I was -- the two classes taken from its former single class are B, income resulting from exploration, discovery or prospecting and C, income from the sale of -- of patents, formulae, or processes.
The omissions are the important thing.
What was omitted was -- was the phrase research or -- research or development of tangible property and in addition, income resulting from patents, formulae and processes was limited to income resulting from the sale of the patent itself, not the use of the patent.
Now, it seems to us that if that departure was purposeful and necessarily very purpose was to exclude the kind of income involved here.
And the Committee Reports -- the Committee Reports expressly say that that was the purpose.
The House Reports which was repeated verbatim by the Senate is set forth the next page of our reply brief on page 12 and you will see that after stating that the World War II law had -- may -- included as eligible -- eligible class of income, income resulting from the sale of tangible property arising out of research and development.
The report notes that that provision was a potential loophole of major dimensions.
And that it was being omitted from the classes of income for which this relief was available because there appeared to be no means of restricting such an adjustment to truly meritorious cases without undesirably broad degree of administrative discretion.
My -- my point is simply that that -- this is the very kind of income that was specifically included in the World War II law and just as specifically deleted from the Korean War law.
And I don't know how Congress could've made any plainer without expressly stating the negative its purpose not to provide relief for this kind of income.
Justice Hugo L. Black: Was this explained in the report?
Mr. Wayne G. Barnett: That was the report I was just (Voice Overlap) quoting from at page 12.
Justice Hugo L. Black: Yes.
Mr. Wayne G. Barnett: That is the House Report as quoted from the House Report, the Senate Report is identical.
It was taken verbatim from the House Report.
Now, the taxpayer --
Justice Hugo L. Black: So that does not --
Mr. Wayne G. Barnett: I'm sorry.
Justice Hugo L. Black: Was there any explanation of the reason either on the report or the --
Mr. Wayne G. Barnett: No more -- no more than -- than the statement that this provision, the provision including research and development income was a potential loophole of major dimensions, because there appeared to be no means of restricting such an adjustment to truly meritorious cases other than by the introduction of an unduly broad amount of administrative discretion.
It's with the administrative necessity and I will in a minute explain what the administrative difficulties were that explains this reference to the need for administrative discretion, if you're going to have that kind of provision.
The -- the taxpayer here says that interpreting discovery to include truly basic inventions which they claim there is this, when I -- I don't mean to deny that, this is up on summary judgment and we accept their characterization.
This is a very important invention.
They say that if you include very important inventions within discovery, you don't have the administrative difficulties that Congress was worried about and I would like to point out what those administrate difficulties were.
Justice Charles E. Whittaker: I don't understand you there --
Mr. Wayne G. Barnett: Yes.
Justice Charles E. Whittaker: -- that should distinguish between that research patent (Inaudible) that are important over those that are less important?
Mr. Wayne G. Barnett: As I understand their argument, they do not argue that discovery includes all inventions.
I think they can speak with themselves, as I understand their argument, they would limit it to basic inventions or important inventions.
I'm not -- I don't want to commit to that position.
The -- the kind of difficulty that you had under the Section 721 of the World War II law as applied to inventions and patents, which were eligible for relief was this.
The relief applied only to the income resulting from the research and development or from the patent.
Now, if the owner of the patent licensed others to use the patent and got only royalty income, the problem was -- was easy.
All of his royalties resulted from the patent.
But if he used the patent himself, manufactured the item, sold the item and the income you got was simply sales income, how could you decide how much of his sales income was attributable to the value of the patent and how much was simply an ordinary manufacturing profit attributable to -- to a fair return on his capital and his investment in plant and equipment to his sales program and labor and all the other factors that go into the production of income.
Well, there was simply no way to do it.
The -- the regulations made it clear, you have to make that segregation.
The -- the manufacture -- manufacturing and selling it -- a product that he developed, who wanted relief had to segregate what part of that sales income was due to the invention and what part was due to manufacturing general demand capital, etcetera.
The only place that the regulations suggested how you might do it was the case where you also licensed others you could use that royalty as a measure or the sort of constructive royalty and charge that part of his income to the patent and -- and that rest elsewhere.
Justice John M. Harlan: Did the treasury recommendation of any kind play a part in the change that was made in 456?
Mr. Wayne G. Barnett: I have no knowledge of that.
I -- I'm sure the treasury was involved in the drafting of whole statute, but I don't know of any specific recommendations about this provision.
You -- you can see the difficulties that are -- were encountered and one must pursue them I don't think we need to.
We cite a group of cases in our brief at pages 47 and 48 applying the old provision.
I was just -- the Ramsey Accessories case is probably the leading case, these other factors are called in the -- 721 bar, the -- the Ramsey factors from the name of that case.
Now the taxpayer says, he doesn't have that problem here because it's a basic invention.
Well, how does he allocate his sales income between the value of the patent and his ordinary manufacturing profit?
He doesn't say in his brief, but if you look at the record at pages 10 and 11 of the record, you'll find out how he did it in his claim for refund.
You will see that he had gross profit and I think, in 1951, the year 1951 was one of the years.
Justice Potter Stewart: That's not the right page.
Unknown Speaker: 8 or 9?
Mr. Wayne G. Barnett: 8 or 9 -- yes, 8, 9.
See at gross profit from the sale of those two items at $10,700,000.
How much of that gross profit from the sale of those two items is attributable to manufacturing and the other factors of production and how much to the value of the patent, the royalty element?
The answer, the reason why it's simple to do is that the taxpayer attributes all of the income to the patents.
Every cent of the income is due to the patents and as he computes it, the net income by the way was about $8,000,000 out of this $10,000,000, as he computes it, although he had $8,000,000 net profit from these two products, he didn't earn a dime on his capital invested in the manufacturing, on his advertising activities, on his sales and promotional activities, during 1951.
All of the $8,000,000 he says was earned actually back in 1946 and 1949 and he just broke even in 1951.
Now, obviously that is not all income, which is attributable to the development of this item.
No doubt that it -- some of it is, we don't deny that and that depends on how good a patent is and how great -- how much the monopoly that is -- is given by the patent is worth, but certainly, they at least also made ordinary manufacturing profit.
I suggest the failure of a taxpayer to be able to suggest how you breakdown your sales income between the patent and the manufacturing and other activities, simply confirms the wisdom of Congress.
And this is the administrative problem that caused them to delete that class of income in taking out a provision which would've required that kind of breakdown and I think ultimately there's no basis for construing the discovery provision in subparagraph (B) to recreate those problems.
Chief Justice Earl Warren: Mr. Cummings.
Argument of Walter J. Cummings, Jr.
Mr. Walter J. Cummings, Jr.: May it please the Court?
There are two questions involved in Searle's case.
First is whether the District Court erroneously granted the Government's motion for summary judgment, instead of letting Searle prove that its Dramamine and Banthine were discoveries within the meaning of the statute.
The second question equally important which I also ought to be able to cover, is an alternative one namely whether the District Court erroneously granted the Government's summary -- motion for summary judgment, instead of letting Searle prove that the income from these two drugs could probably be classified under the last sentence or on the clause of the statue and the regulations in question.
Under Rule 42 (b), to answer the question that Chief Justice put to Mr. Barnett, the remaining issues by court order have been held in abeyance, such issues as involving competition of amount of abnormal income, the years of attribution and so forth.
The facts are largely in dispute as the Government conceded in the District Court but some of them are disclosed by the error record that's before this Court.
As to the facts established by this record, the record shows that Searle is seeking to recover part of the excess profits taxes that it had paid in 1950 through 1952, on income from the discovery of these drugs.
Dramamine is, of course, the famous anti-seasick or motion sickness remedy, whereas Banthine, is an equally sensational remedy for the treatment of peptic ulcers, normally rendering surgery obsolete in such cases.
Searle advised the District Court that it intended to prove that unlike all it's other products, both these drugs were breakthrough discoveries, involving new compositions of matter and that their effect on the human body constituted an unprecedented approach to the treatment of motion sickness and peptic ulcers.
Searle intended to show that the contemporary medical literature of other publications termed these two drugs discoveries for they were not mere improvements on existing drugs.
Their large sales and widespread in the -- imitations were further indicia that both of these were genuine or breakthrough discoveries.
But in the alternative, Searle intended to prove at the trial that it was reasonable and appropriate within the meaning of the treasury regulations, to classify the income from these drugs under the omnibus last sentence of the statute, even if it should not qualify under subparagraph (B) in the discovery provision.
The Court of Appeals held that the word “discovery” as used in the statute does confine to natural resources.
During the three years in question, Searle's excess in income tax payments totaled about 19 million, of which the complaint seeks to recover about three and a half million.
But the judgment below did not determine that Searle was entitled to recover any part of this amount and in fact under the complicated computations that Mr. Barnett had adverted to, the District Court might conclude that the plaintiff indeed was not entitled to recover the entire amount or any of it.
In this connection, the Court will be interested to note that only modest recoveries were allowed under the equivalent provisions of the World War II Act.
This Korean War excess profits tax act, which was repealed in 1953, accords special treatment to income resulting from discovery and other classes of income, if it -- it falls within the definition section of the Act and the definition applies to income, abnormal in kind or abnormal at amount.
Searle's incoming question, it contends is abnormal in amount.
As its principal ground on the District Court, the Government's motion for summary judgment claimed that discovery does not include products prepared through research and development.
The motion did not at all mention Searle's alternative claim or relief under the last sentence of the statute.
As to both of these grounds and in the teeth of the regulation, the District Court held that the plaintiff's income was not entitled a relief merely because it arose from research and development.
Our first point is that the ordinary meaning of discovery would include these drugs.
Amphetamine sulfate was so termed by the Third Circuit in the Smith, Kline and French case recently and the salts for the treatment of anemia is so described by the Eighth Circuit throughout its Preon opinion.
Interestingly enough at the famous (Inaudible) hearings, the investigation of the drug industry last year, important breakthrough drugs like these, were referred to as discoveries.
Justice John M. Harlan: Not in the context of the statute?
Mr. Walter J. Cummings, Jr.: No, the particular statute was not however, in the context of the statute and the very hearings on the statute, two other drugs were mentioned Mr. Justice Harlan, they were Aureomycin and ACTH.
The Tax Court also used the term discovery on a non-mineral sense, when it was dealing with the equivalent provisions of the World War II had.
In two cases that I found and preparing for the day and are not in our brief.
In the W.P. Davis case in 5 B.T.A. 1195, the court referred the plaintiff's hosiery machine as a discovery and in Steel or Bronze Piston Ring Corporation in 13 B.T.A. 636, the court referred at the plaintiff's piston rings as a discovery, so the relief -- so that the word was used in a non-mineral sense by the Tax Court itself in administering the earlier provisions.
The term is of course applied to really new drugs by common usage and there was so applied in the medical literature and the other newspaper articles dealing with these two drugs.
Learned articles on such other drugs as insulin and penicillin referred to them as discoveries and as even Mr. Justice Brennan and Mr. Justice Stewart noted, the Constitution of course, uses the term discovery in a non-mineral sense.
Justice Felix Frankfurter: Mr. Cummings --
Mr. Walter J. Cummings, Jr.: Yes.
Justice Felix Frankfurter: And before that literacy is defined in the Oxford Dictionary, this may shed some light on the constitutional use of discoveries.
Mr. Walter J. Cummings, Jr.: Yes.
Justice Felix Frankfurter: According to the Oxford Dictionary, discovery is a -- technical American, United States mining term.
The first quotation they give is in 1802.
It may well be that in course of time with those quixotisms and oddities by which words change their meaning and --
Mr. Walter J. Cummings, Jr.: Yes.
Justice Felix Frankfurter: -- and their color without being disloyal to each other, themselves.
It may well be that discovery in the -- in the constitutional draft of the 1787, at its generalized meaning of the disclosure of something new and that in America, even if they're not in England, discovery does have a technical application to the-- the processes of mining.
Mr. Walter J. Cummings, Jr.: Well, that is one of the definitions of course, but it does not the colon --
Justice Felix Frankfurter: No, no, no.
Mr. Walter J. Cummings, Jr.: -- that (Voice Overlap)
Justice Felix Frankfurter: But -- but I mean that may shed light on why that in 1787 discovery it may've had this generalized meaning and not yet received.
I don't suppose there was so much mining going on except surface scratching in 1787 in United States.
Mr. Walter J. Cummings, Jr.: Well the whole point of a difference between discovery and invention was explored by Judge Cranch back in 1841 in the Camper case which I don't think we cite it, it's an early federal case, but in that, he concluded that at least as far as the Constitution and the patent laws go, that the words are used synonymously.
Justice Felix Frankfurter: Yes, I know.
Timeless picture were --
Mr. Walter J. Cummings, Jr.: I know.
Even the treasure department apparently recognizes that drugs can come within the subparagraph for it has settled the claim involving an antibiotic in one of Searle's competitors.
And then as this very record show the Internal Revenue examining officer in this case conceded that at least Dramamine constituted a discovery within the ordinary meaning of the term.
Searle is of course not claiming that every patented drug is a discovery, but only that the rare pioneer or breakthrough drugs constitute discoveries.
The same is true with Polaroid and its --
Justice John M. Harlan: Why -- why draw that distinction?
Mr. Walter J. Cummings, Jr.: Because we don't think that the statute was meant to apply to mere improvements -- mere improvements, which just grow out of research and development.
They're not really truly discoveries their mere improvements are never referred to as discoveries.
Justice John M. Harlan: You mean it would apply under your view, the all product patents?
Mr. Walter J. Cummings, Jr.: We're not claiming that the word discovery applies to all product and --
Justice John M. Harlan: And draw distinction even there, as to the magnitude or significance of the invention.
Mr. Walter J. Cummings, Jr.: That's correct.
Justice John M. Harlan: And I was wondering what the basis -- what the reason for drawing that --
Mr. Walter J. Cummings, Jr.: Well I think, it's the same on -- it grows out of the patent law actually as was discussed by Chief Justice Taft in his Idaho process case.
He said that the Court had differing attitudes toward genuine discoveries and slight improvements.
In other words, they've often had to draw the line between genuine discoveries and mere improvements.
You wouldn't have anything really abnormal, if it was a mere improvement.
It couldn't possibly qualify.
It would just be research and development.
Chief Justice Earl Warren: But any basic patent is a discovery?
Mr. Walter J. Cummings, Jr.: A pioneer patent, yes not an improvement patent.
It would have to be something startling as Mr. Isaac Barnett will doubtless tell you about this Polaroid camera when his case is reached.
That we weren't given an opportunity to prove that these two drugs were of that magnitude, that's what we would like to -- enable to do in the District Court.
In the -- in administering the same provision under the World War II Act, the Tax Court seemed to reflect the same distinction between genuine discoveries or mere improvements.
In the Ideal McCulloch case, which is mentioned in our brief, where the taxpayer was denied relief, where it had merely improved its vacuum tubes.
Our point is that discovery should be given its ordinary meaning here, because Congress in our opinion has not specified any other meaning.
One such example of this rule, in this Court is the Avery versus Commissioner in 292 U.S., where you were confronted with the meaning for the word, received.
And the Court said Congress hadn't shown any other meaning that should be given to receive, so it was given its normal meaning and dividends were held received in the year in which they actually were received.
The legislative history, which is to be discussed by Mr. Isaac Barnett for Polaroid, also shows that Congress intended no restrictive meaning.
Because of time annotations, I won't be able to go into the legislative history except to state that in fact the only link between Section 456 and natural resources in the 1950 congressional debates or hearings or Committee Reports, was one remark by a representative of the mining industry quoted at page 70 of the Government's brief.
The brief significantly omits the next sentence which in effect states, “We, the mining industry probably won't need Section 456 for ourselves, but it is a good idea for other industries.”
The Government has collected a great many statutes in its principal brief and appendix to show that discovery has a narrow mineral meaning here, but unlike the headings and text of all those statutes, neither Section 456 nor Section 721 its precursor, contains any heading or text showing their applicability was confined to the natural resources industry.
The same was really true on analysis we believe, for the internal content of this statute.
The language used in subparagraph (B) is exploration, discovery or prospecting, or any combination of the foregoing.
Each word then is given an independent significance, whereas the Government urges that discovery is covered only when in combination with exploration and prospecting in mining operations.
In other words, when Congress intended to limit discovery to no resources, it has always so specified and we've given many examples and so as Polaroid in its brief.
The main ground for the contrary opinion by the First Circuit was the application of the maxim noscitur a sociis.
Well in accordance with many text writers on the subject of statutory construction such as Sutherland, this Court has often refused to apply the maxim.
In the Russell Company case for example in 261 U.S. that company argued that the word, “contract” in a statute, had to be limited to private contracts because of it's word association, with the word, requisition.
Well, the Court included Government contracts.
And likewise in the Stockholms Enskilda Bank case in 293 U. S., the taxpayer argued that the word, “obligations” must because of its word, association be confined to notes and bonds.
Again, this Court refused to consider the adjacent words.
As in both those cases then, the noscitur maxim should not be found to restrict the ordinary meaning of discovery, specially since the application of Section 456 to a discovery of this type, does inform that the basic purpose of Congress to give relief to have normal income which is attributable in part to prior years.
To our knowledge, the noscitur maxim has never been used to defeat the purpose of the statute and the Government has cited no cases in support of applying the maxim here.
The only case cited by the First Circuit in favor of applying the maxim here was an 1877 case, in which its application was in accord with the basic purpose of the statute, but here the basic purpose of the statute would not be so satisfied.
If you aren't going to apply the noscitur maxim, you have to look anyway at the phrase as it was immediately derived in Section 721 of the World War II Act.
That's where this phrase directly came from.
And there it is defined as covering both income resulting from exploration, discovery, prospecting, research or development of tangible property, patents, formulae or processes or any combination of the foregoing.
So that applying the maxim, in the setting shows that discovery was not used only in the mineral sense.
Justice John M. Harlan: I thought they eliminated the -- they eliminated which you gave comfort out of under the old 721?
Mr. Walter J. Cummings, Jr.: Yes, but you have to see where the phrase was derived from.
It was derived there and it's obvious that upon -- applying the maxim there, it could've been used in the mineral sense and just cutting out those other words, then suddenly turns, it changed the meaning of discovery.
Exploration is not confined to natural resources either.
Its common meaning is to seek for or after or to examine and in the Keystone Brass Works, the Tax Court referred to Keystone's exploration in developing new bushings.
In other words, the term was there used in a non-mineral sense, in the sense of preliminary investigation.
The Government and the District Court relies specially on the elimination of the words research and development from Section 721.
And the proposed regulation provided for no relief whatever, if research and development were involved, that is true.
But that regulation was abandoned after protest in favor of the present regulation which takes the exact opposite position and states that Section 456 is applicable to research and development income if the income is otherwise properly includable within the class of income to which the section is applicable, thus, of course, including discovery income or income under the Omnibus.
Congress has nowhere stated the products arising out of research and development cannot constitute discoveries and the regulation is finally adopted, so permits.
In other words, there is nothing to show that the removal of the words, research and development, was meant to confine the discovery language to the mining industry.
Speaking of loopholes as Mr. Barnett did a few minutes ago, researchers of course, have wider concept in discovery and although the World War II Act's inclusion of those phrases supposedly threatened to create a loophole no such problem is presented by genuine discovery, which is a rare phenomenon.
Even under Section 721, recoveries were modest so that any loophole was at best potential.
In the light of the experience of the cases under the World War II Act, the Government's claim is unwarranted that millions of dollars would be jeopardized by affirming the holding below.
After all the statute of limitations has expired, this particular statute was repealed in 1953, and the regulations themselves have very rigorous test so that there are ample safeguards for any so-called rate on the treasury.
As to discoveries, we think there need to be no administrative difficulties for income from the new product can be specifically identified and segregated as it was here.
Consequently, the reasons for eliminating research and development do not exist with respect to a discovery.
The petitioners claim that discovery must not be interpreted and include patentable discoveries, but fear of overlapping subparagraph (C), but this assumes that the two paragraphs are mutually exclusive, they were not.
The draftsmen understood that income might be quoting the draftsmen, classified and more than one of such paragraph -- subparagraphs.
The language of the statute itself so states, in which case, the income is supposed to be classified under the one which the taxpayer irrevocably elects.
In construing the statute, of course, the purpose of the statute looms very large and the main object of this statute was the tax benefits attributed to the large military budget and the wartime economy.
Neither those factors were involved with respect to Searle's or Polaroid's products.
Section 456 was enacted to give relief whereas here, the profits are not attributable to military spending or the wartime economy.
As the Tax Court stated in the Ramsey Accessories case, Congress wanted these relief provisions to be applied sympathetically.
The House Report which was approved by the Senate Finance Committee so states, the House Report 146, the Report states, “Equitable considerations demand that every reasonable be -- precaution be taken to prevent unfair application of the tax in abnormal cases.”
The weight of the burden imposed carries with it at the commensurate need for restricting its application to the cases for which it was designed.
Years of effort go into a discovery and its competitive advantage that will last on the short time and therefore, it's certainly within the spirit of Section 456 to afford relief here.
The discovery of minerals and the like was no more deserving of relief legislation than the discovery of vital importance to the health of millions of persons.
And there is no intention on it at all of Congress to confine subparagraph (B) to the mining industry.
The mining industry was already well taken care of in many other provisions of the Code including certain sections of this very statute.
The essence of Section 456 is to recognize the unfairness of bunching for heavy taxation in one year discovery income which is in fact, attributable to several years.
Congress intended that abnormal income from discovery, if it can be shown to be attributable to other years, should be taxed accordingly.
All Searle wants is an opportunity to prove that income, in fact, was attributable to other years and it's consequently entitled to relief under Section 456.
Justice Hugo L. Black: As I understand the section, no such question was presented by cannons of the law.
Mr. Walter J. Cummings, Jr.: That's correct, Your Honor.
In order to arrive at a solution of this problem, the District Court's order simplified it and said he would only pass on whether this could fit within subparagraph (B), the discovery provision or within the Omnibus Clause which I'm now about to discuss.
Our second point and then it is an equally important point is that Searle's and Polaroid's income in the alternative, constituted a special class of abnormal income under the last sentence of the statute.
That's a very short sentence.
It appears at the middle of page 3 of our brief, the blue brief and states only, “The classification of income of any class not described in subparagraphs (A) to (D), inclusive, shall be subject to regulations prescribed by the Secretary.”
One has to turn to the House Report on the World War II statute to see what the reason was for including an Omnibus Clause.
And the same House Report Number 146 that I read from a few minutes ago gives the reason.
It is stated there that “Experience with excess profits taxes both in the U.S. and abroad, has demonstrated conclusively that relief in abnormal cases cannot be predicated on specific instances foreseeable at anytime.
The unusual cases that are certain to arise are so diverse in character and unpredictable that relief provisions couched in other than general and flexible terms are certain to prove inadequate and that is why this catchall clause or Omnibus Clause was inserted.
The report goes on to state that existing law provides for adjustment with respect to six specific classes and the instant statute was reduced to four, received during the taxable year subject to the excess profits tax.
These specific items were allowed to be spread over the years to which they're actually attributable.
Your Committee feels that the relief afforded by this provision should not be limited to these specific items, but should be available also with respect to any item of abnormal income as such income is defined in the bill.
And then little later, enter the -- detailed discussions of the bill, they go on to the same effect to say that since the types of abnormal income cannot be predicted in advance, you can only grant adequate relief by extending the scope of this section and that's why this last sentence was added.
Justice John M. Harlan: Would that -- would that mean that the -- that the Commissioner or the Secretary has got the right to enlarge the --
Mr. Walter J. Cummings, Jr.: He has never done so, Mr. Justice Harlan, instead by regulations.
He's given that right to the taxpayers since 1944.
He said to the taxpayer may group income in such other classes, but they have to be similar classes.
They have to be reasonable and appropriate.
In other words, the regulation sets up -- sets up three standards.
A taxpayer under this Omnibus Clause is permitted the group income in similar classes, as those specified in paragraphs (A) to (D) as are reasonable and appropriate and that is shown at the regulation at the bottom of page 3 of our brief.
“Similar” of course, does not mean identical or this Omnibus Clause would become entirely meaningless.
Again, one has to resort to a dictionary definition and “similar” according to Webster means, somewhat alike.
Certainly, a discovery of a new product is similar or somewhat alike to the discovery even of a new mine, except that the type of business is different.
In other words, the class of income from newly discovered products is certainly similar to, if not identical with the class of discovery mentioned in subparagraph (B).
Justice John M. Harlan: Has the Commissioner allowed the deductions for categories other than those specified in the statute?
Mr. Walter J. Cummings, Jr.: The tax -- yes the Tax Court at least, has.
The Commissioner in our case is not giving us the reason that research and development were involved, but as you can see from the last sentence of that regulation though that was an erroneous reason because --
Justice John M. Harlan: What are some -- what are examples -- do you cite cases in your brief where under that provision there had been allowances?
Mr. Walter J. Cummings, Jr.: In the Premier Products case, not in our brief, again, I found it preparing for today, 2 B.T.A. 445, the catchall is applied to insurance proceeds.
And then in several other cases after that, such as the WB Knight case, which is in our brief in 6 B.T.A. 519, the court pointed out that the statute applies to not only the lettered classes but also to the omnibus or the catchall class.
“Similar,” under the regulation in the setting, means that if a taxpayer classifies separately a readily identifiable segment of income, differing from its other products and attributed to -- attributable to prior years, such a class would be similar to the classes specified and should qualify for relief, if the other test of the statute and the regulation is satisfied.
Yet, the District Court by its summary judgment would not permit Searle to meet the three tests established in the regulation.
So it should not have been cut off by summary judgment from showing that it was reasonable and appropriate for it to group its income from Dramamine and Banthine in a separate class.
Of all Searle's drugs, these were the only two that were completely new in concept and successfully performed in options and not previously performed by earlier pharmaceutical products.
None of the other drugs marketed by Searle was truly new.
In fact, this was recognized by the Government itself in 1955 when it rejected Searle's claim for refund of World War II excess profits taxes, because at that time, Searle had no new products as it's shown at pages 29 to 38 of the record.
At the trial, Searle would also to show that the income from these two drugs was attributable to prior years under Section 456 (b) and was abnormal in amount between the requirements of Section 456 (a) (1).
Thus, it would be entirely immaterial whether these drugs were produced as abnormal or routine part of Searle's business, which was the only test used by the Commissioner.
Instead it's enough if it's abnormal in amount.
What does the Government say about the Omnibus Clause?
In its reply brief, it makes three points.
First of all, it states that it was inadvertently left in the statute.
Well that is not true, because the legislative history in 1950 shows that the House conferees insisted that it be put back in the statute after the Senate left it out.
The staff reported the joint Committee on Internal Revenue's taxation in 1950, acknowledged that the Omnibus Clause give relief to a fifth class, namely, quoting five, “Income of other classes permitted under regulations prescribed by the Secretary.”
Senator George made a similar statement on the senate floor, but this gave the Secretary of the Treasury the authority to prescribe classifications in addition to those prescribed in the bill.
In other words, it could have been inadvertent.
The Government also claims that the sentence can have no operative effect because the definition section, Section 456 (a) (1), is confined to income described in paragraph (2).
Well that gives a very narrow meaning to the word, described.
Instead described applies not only to the four classes specified in subparagraph (2) but also, of course, to the omnibus classification.
That's part of subparagraph (2) as well.
If you gave the narrow meaning to describe that the Government gives to it, the catchall or Omnibus Clause would have no effect at all, despite the fact that the House put it back for the very same reasons that was put in the World War II Act, namely, that would have been unfair without it.
Finally, the Government claims that the last sentence of the regulation under this Omnibus Clause means that income involving research is excluded unless it qualifies under one of the four classes listed, namely, A, B, C, or D, but the regulation does not so state at all.
The last sentence of the regulation applies to any class of income to which the principle of Section 456 and I'm quoting the statute of the regulation, “Is applicable”.
In other words, the last sentence, the regulation applies to any class A through D or one selected by the taxpayer pursuant to the last sentence of 456 (a) (2) in the regulations.
The reason for eliminating relief to research and development income also does not extend the income within the meaning of the last sentence for income is not entitled to relief under that sentence unless the three tests of the regulations are met.
In other words, you have to show that it's similar, reasonable and appropriate.
Also you have to show that the income is attributable to prior years under Section 456 (b).
Thus, is it foolish to assert that if we prevail income abnormal in amount would automatically and suddenly qualified for relief, instead the attribution test at 456 (b) has to be met, the three tests of the regulation under the Omnibus Clause have to be met and many other requirements of the very rigorous regulations would still have to be satisfied.
The District Court's holding that income attributable with recent surge has ipso facto excluded under Section 456, was certainly erroneous and in conclusion, the judgment of the Court of Appeals should be affirmed and Searle should be given an opportunity to prove that Dramamine and Banthine were discoveries within subparagraph (B) or if they were not, that the income was within the omnibus sentence, the last sentence of the section and the regulations there under.
Justice John M. Harlan: Was the Commissioner -- has construed his regulation, does not cover in your situation an effect, is that it?
Mr. Walter J. Cummings, Jr.: The only reason given, Mr. Justice Harlan in denying our claim was that if the drugs were produced as a normal or routine part of Searle's business, but that is patently wrong because as I stated earlier, the -- and as Mr. Barnett stated earlier, the definition section, Section 456 (a) (1) applies to income whether it is abnormal in kind or abnormal in amount.
Our income was abnormal in amount.
So the reason given for not committing the catchall clause to apply just was an invalid reason.
Justice Charles E. Whittaker: How would it be abnormal either in the kind or amount if it is just routine with you?
Mr. Walter J. Cummings, Jr.: Because the -- whether it's abnormal in kind doesn't matter, but it satisfies the second test of the statute which is quoting from page 2.
“If the taxpayer normally derives income of such class, but the amount of such income of such class includable in the gross income taxable year is an excess of 115% per annum.”
We can satisfy that test, Mr. Justice Whittaker and would like to do so in the District Court.
Our complaint sets out mathematically why we can meet the abnormal in amount test.
Chief Justice Earl Warren: Number 169, Polaroid Corporation, Petitioner, versus Commissioner of Internal Revenue.
Argument of Isaac M. Barnett
Mr. Isaac M. Barnett: My secretary tells me that no matter how this case is decided, Mr. Barnett will win.
The issue in this case is whether Polaroid's income from this -- from two scientific discoveries is entitled to relief as abnormal income under Section 456 (a) (2) of the Korean War excess profits tax laws.
The Tax Court and the Court of Appeals for the First Circuit, while acknowledging that these discoveries were revolutionary discoveries held that no scientific discovery can qualify for relief under Section 456 and decided against Polaroid.
Our contentions are similar to those advanced in the Searle case.
First that Polaroid's income from its scientific discoveries falls squarely within the class of income described in 456 (a) (2) (B) as income resulting from discovery; 456 (a) (2) (B) as -- as was explained in the prior argument, reads income resulting from exploration, discovery or prospecting or any combination of the foregoing extending over a period of 12 months.
Secondly, if it does not, if it's not entitled to come under (B), that such income was entitled to classification under the last sentence of 456 (a) (2), which provides for additional classifications by the Secretary.
And to get that again before Your Honors, that last sentence reads, “The classification of income of any class not described in subparagraphs (A) to (D) inclusive, shall be subject to regulations prescribed by the Secretary.”
We contend further that a proper interpretation of the treasury regulations issued to implement this last sentence that under such an interpretation, Polaroid's income qualified for relief.
Now the two scientific discoveries that were involved in this case, are the Polaroid Land Process and the Polaroid 3-D Synthetic Polarizer.
The Polaroid Land Process consisting of the Polaroid Land camera and film is a photographic system in which by one step dry processing, the developing and printing of the picture take place simultaneously within the camera, enabling the user to obtain a finished dry positive print directly from the camera within 60 seconds.
Prior to the conception of the process, no photographic process existed whereby the picture was taken, the negative developed and a positive print obtained directly from the camera by a one-step dry process.
The 3-D Synthetic Polarizer is the light polarizing material incorporated in the viewers, used by the audience in the viewing of three dimensional motion pictures to create the illusion of three dimensions and the exhibition of three dimensional motion pictures, could not have been undertaken without it.
That the -- our case differs with the Searle case in that, we already have had the trial.
The findings of fact of the Tax Court establish that these discoveries were revolutionary scientific discoveries creating new odds and that the incoming question resulted solely and entirely from the discoveries.
We differ from the Searle case in another respect.
We have a stipulation in our case, in which the Government and Polaroid have agreed in the event that this case is decided favorably to Polaroid, upon the amounts of net abnormal income arising from the discoveries and upon the portions thereof to be attributed to prior years.
So in answer to your question, Mr. Chief Justice, if we should win here, we do not have to go back.
We have a -- findings of fact on -- on the facts that we have revolutionary basic discoveries and we also have a stipulation with respect to the mathematical answers under Section 456.
Justice Hugo L. Black: Is your argument also that there would have to be a finding of facts in each case to see if it happened to a revolutionary?
Mr. Isaac M. Barnett: Your Honor, I -- I think that the way this is construed under 456, I think Mr. -- you, yourself, Your Honor in the recent -- in your recent Convertible Top case, where there's an indication that the word, discoveries couldn't report to the type of patent that was involved there.
I think that you'll find it in the patent laws, there is a distinction -- in the cases involving patented inventions, there is a distinction between a basic patent which advances the odd substantially and one which maybe entitled a patent, but it's merely an insignificant improvement.
Now the court below seems to think there would be a large administrative problem connected with determining which is significant and which isn't.
It might be a question, but -- and it can't very easily be answered in the abstract, but again, it seems to me that once you hear the facts with respect to any particular invention, you know whether it's significant or not.
And in our case, despite the fact that we -- they've decided against us, both the Tax Court and the Court of Appeals said they were revolutionary inventions.
They thought --
Justice Felix Frankfurter: May I refer (Inaudible) that it is -- the answer is easy.
If it isn't -- if it isn't significant, it is non-invention.
Mr. Isaac M. Barnett: That --
Justice Felix Frankfurter: And it can't be -- if it's an invention, it must be significant.
Mr. Isaac M. Barnett: Well, I just want to say, Your Honor, that it seemed to me that the problem might --
Justice Felix Frankfurter: These are opinions that convey that property.
Mr. Isaac M. Barnett: It might be, for example like was before you in an entirely different field in the (Inaudible) case.
You can't state in the abstract, but once you see the facts, you know whether what the answer is one way or the other.
A revolutionary invention creates tremendous surprise and you find through the lay literature, through the scientific literatures, also lots of indications as to whether it is recognized as revolutionary or not.
Justice Felix Frankfurter: This statute is still in force, upon with all facts of deterrent patentability at the same time.
Mr. Isaac M. Barnett: I think Your Honor would have to determine as to -- there would -- there would have to be a determination as to whether there is a significant invention involved in the -- in the process or the -- or the product.
Justice Felix Frankfurter: They're not using the significant and more dramatic phrase of flash of genius, are they?
Mr. Isaac M. Barnett: Well, yes, a flash of genius Your Honor, but there could be different flashes of genius.
[Laughter] And that -- my - my namesake in making this argument has so paneled principal argument that has been made by the Government in his brief so far which had -- has been the basic argument that before these words, exploration discovery of prospecting were used in Section 721 (a) to (c) of the Second World War Act from which our Section, 456 (a) (2) (B) is derived, the words have become in the Internal Revenue laws, words of odd applicable only to natural resources.
That's their basic argument and we think that's based on an improper analysis of the legislative history.
And in view of the time involved, I'd like to confine most of my argument of that legislative history.
In support of it -- of its contention, the Government has called attention to two statutory provisions.
Both are resonating in the Revenue Act of 1918.
Section 337, which established a ceiling on the rate of tax in the case of, “this is from the statute,” “A bona fide sale of a mine, oil or gas well, that's right in the statute,” the principle value of which has been demonstrated by prospecting or exploration and discovery work and the other section to which they refer is Section 234 (a) (9) of the 1918 Act, which in providing for a depletion allowance stated in the case of mines, oil or gas wells discovered after March 1, 1913, the allowance was to be based on the value at the date of the discovery.
Chief Justice Earl Warren: We'll recess now.
Argument of Isaac M. Barnett
Chief Justice Earl Warren: 169, Polaroid Corporation, Petitioner, versus Commissioner of Internal Revenue.
Mr. Isaac M. Barnett: Mr. Chief Justice, may it please the Court.
When we closed yesterday, I pointed out that the Government in contending that these were words of arts applicable only to natural resources relied on two sections of the 1918 law; one, in which the words prospecting, exploration, and discovery were used and the other in which the word discovery was used.
The main emphasis of the Government has been on Section 337 which the Government asserts was the original source of Section 721 (a) (2) (C) and Section 456 (a) (2) (B).
We agree that in attempting to find the intent underlying 456 (a) (2) (B), it is helpful to go back to the Revenue Act of 1918 where we believe that the Government has gone back to the wrong section.
Section 456 is a Section designed to give relief for abnormal income in an excess profits tax year.
The 1918 Act also had this Section giving relief for abnormalities and income and an excess profits tax year, and that with Section 327 (d), which Your Honors will find on page 25 (a) of the appendix to the petitioner's brief.
Section 327 (d) provided that where owing to abnormal conditions affecting the capital or income of the corporation, the tax would work in exceptional hardship upon the corporation evidenced by a gross disproportion between the tax computed without benefit of that Section and the tax computed by reference to the representative corporations referred to in Section 328.
The tax was to be determined as provided in Section 328 and under 328, an adjustment of the tax was made to bring it into line with the tax imposed upon representative corporations in the same industry.
To understand just what were the abnormal conditions referred to in 327 (d), the history of this Section is illuminating and we believe particularly significant in construing Section 456 (a) (2) (B).
As originally introduced in the House, Section 327 mentioned three abnormal conditions.
In the Senate, the bill was considerably expanded to include a number of additional abnormal conditions and one of them is particularly pertinent.
I'm referring to Section 327 (e) (3) (B) of the senate bill which Your Honors will find printed on pages three and four on petitioner's reply brief.
That subsection in the senate amendment listed as an abnormal condition, the situation where the net income for the taxable year is abnormally high due to the realization in one year of extraordinary gains or profits derived from the sale of property, the principal value of which has been demonstrated by prospecting or exploration and discovery work.
And you will note Your Honor that there's no mention as there was in 337, specifically in the case of mines, oils or gas wells.
Now in conference, the language of Section 327 was changed to the form in which it was primarily enacted, but the language changes were intended only to consolidate into one general classification, all of the various classes of abnormal conditions listed in the senate amendment and not to eliminate any of them.
This intention to amalgamate and not to eliminate is confirmed by the Conference Committee Report by statements of various senators on the senate floor and by a ruling of the Solicitor of Internal Revenue to which we have referred in our brief.
The Solicitor of Internal Revenue had the decision, the question of whether a manufacturing company which had spent substantial sums and to use his words, experimental and discovery work in developing a secret formula which had given the Company a virtual monopoly which sums have not been capitalized, was entitled to relief under Section 327.
He stated that in order to learn just what Congress intended by the words abnormal conditions in Section 327 (d), it was necessary to resort to the list of abnormal conditions contained in the senate version of that Section and he ruled that such a company was entitled to relief under Section 327.
The use of the words experimental and discovery work shows that he did not regard those words as limited only to the extractive industries.
He had to find abnormal condition under the law.
In order to qualify it for relief he found it in the section to which I have referred, which refers to exploration, discovery and prospecting.
It is interesting to note that at the same time as the Senate was amending Section 327, it introduced them to the bill by way of amendment Section 337 upon which the Government relied.
This time coincidence enables us to make a pertinent comparison between these two sections.
Section 337 was admittedly a Section designed to give relief solely to mines, oils and gas wells.
And the Senate left no doubt as to that intention by saying so in so many words.
In both Sections explicitly, it says in the case of mines, oil or gas wells.
Had the Senate had similar intent to Section 327, it would be expected that it would have shown it in similar fashion, but it did not do this in Section 327.
On the contrary, it used the general word property in listing as an abnormal condition, extraordinary gains or profits derived from the sale of property, the principal value of which has been demonstrated by exploration or discovery work.
Had the Senate the intent of limiting the provision in 327, as it had done in 337, it would have been easy for the draftsmen to have provided in the case of mines, oil or gas wells extraordinary gains or profits derived from the sale and so forth.
That the words prospecting or exploration and discovery work as used in the Senate's version of 327 were understood to have general meaning applicable to oil corporations and oil industries, it's not only confirmed by the opinion of the Solicitor of Internal Revenue to which I have referred, but also by the action of the Conference Committee in merging all the classes of the senate amendment into one general classification.
Justice John M. Harlan: What is that?
Mr. Isaac M. Barnett: 1918.
Justice John M. Harlan: 1918?
Mr. Isaac M. Barnett: Yes, Your Honor.
That these words had reference only to the operations of the extractive industries, they could not have been so merged.
Moreover, if one looks at the Senate Committee report which accompanied Section 337 and Your Honors will find that printed on page 25 of the Government's brief in the Searle case, that Section has headed gains derived from prospecting, exploration, or discovery and one notes that the Senate saw fit in addition to giving its reasons for the enactment of Section 337, to call attention in that subdivision to the increased depletion allowance allowed under Section 234 (a) (9).
No reference whatever was made to Section 327.
And here is a situation where they just got through amending 327, and if it deprived only to the extractive industries, it would have been expected that it would have mentioned it under this heading gains derived from prospecting, exploration, or discovery.
So, that under the 1918 Act, we have history to the effect that these words have been used in a context applicable to others in the extractive industries.
We now come to Section -- to the World War II law.
Abnormalities in tax year income were covered in the World War II law in Section 721.
And with respect to such abnormalities, Congress introduced a new concept to determine abnormality by classes of income, yet it is not unreasonable to assume that in establishing the class of income described in 721 (a) (2) (C), which was income resulting from exploration, discovery, prospecting, research or development of tangible property, patents, processes or formulae, Congress was not unmindful of the formal of provision in Section 327 (d) of the 1918 Act and of the history of that Section and how it was interpreted.
In fact the phrasing of Section 721 of the original Act, which Your Honors will find printed in the footnote on page 6 of the Government's reply brief, I think demonstrates that Section 721 was patterned on 327 (d) of the 1918 Act.
You will note that the words grossly disproportionate are used, instead of the mathematical formula for determining abnormality that later resolved it.
These are the same words that were used in Section 327 (d), but whether it was packing on the 1918 Act or not, I submit that the legislative history which I have just recounted, demonstrates that the words exploration, discovery and prospecting had not become words of art referring only to the mining industry.
It is also clear that the provisions of Section 721 in all its subdivisions were intended to apply to corporations in oil industries and this was confirmed by the statements on the senate floor to which we have adverted in our brief.
Senator George was asked for example as to what was the additional benefit to the mining industry and he replied that provision was helpful not only to a mining corporation, it was helpful to any type of corporation and I might add that applying the principle of noscitur a sociis to 721 (a) (2) (C), you couldn't come up with any common denominator that the words apply only to the mining industry.
Chief Justice Earl Warren: Did Senator George (Inaudible) the bills?
Mr. Isaac M. Barnett: I think he was, Your Honor.
Now Section 721 (a) (2) (C) was much broader than the provisions in the senate version of 327 of the 1918 Act.
There was added to the concept of abnormal income, abnormal income resulting from research or development of tangible property.
Now, the word "research" is a very broad word.
It does not necessarily mean only laboratory research.
We speak of legal research.
There is research in business, in marketing methods, in manufacturing costs, and various analysis and surveys.
And this addition which was added in the 9th -- in the Second World War Act of the word "research" led to a substantial number of -- a substantial increase in the applications for relief.
Now let us consider Section 456 (a) (2) (B) in the light of this legislative history.
This Section, according to the Committee reports, is Section 721 (a) (2) (C) with the word "research" or development of tangible property left out.
Now, if this was a brand new Section that was originally created in the Korean War then maybe the principle of noscitur a sociis may conceivably have applications.
But what it was, was a derivation of an old Section and to find out what the meaning of these words were, you have to go back to the old Section and certainly the principle of noscitur a sociis doesn't -- in 721 (a) (2) (C) doesn't result in the holding that it applies only to the natural resource industries.
Unless there was a clear indication of attempt to change the meaning of the words which were left in, in 456 (a) (2) (B) by taking out the words research or development, the words exploration, discovery and prospecting continues to have the same general meaning applicable to all types of corporations, as they had, we submit in Section 721 (a) (2) (C) and before that in 327.
Now there was no evidence that by deleting the words research and development, Congress intended to change the meaning of the words it retained and the Government concedes that the word discovery in 456 (a) (2) (B) has the same meaning as in 721 (a) (2) (C).
Now, Congress has told us the purpose of the deletion of the words research and development of tangible property.
It was to plug a potential loophole found to exist in the old law.
Now, a loophole is getting something to which you're not entitled, getting a form of relief to which you're not entitled.
Now, what was this loophole?
We venture to suggest that the loophole which had -- was one which have been created by the extension of qualification of relief under Section 721 (a) (2) (C) generally to research or development of tangible property which had not in and of itself been recognized as abnormal condition under 327 (d) of the 1918 Act.
This potential loophole stems from the inability in certain cases arising under Section 721 (a) (2) (C) of establishing what income, if any, resulted from the research and development.
It had the company that had a product.
It did some research and development and improved the product, and if so, the improved product, you couldn't tell what demand there was for the product -- what demand there would have been from the product during that year even if that hadn't been improved.
So, it was impossible to separate the demand for the basic product -- from the product improved by the alleged research and development and that was the potential loophole which Congress sought to strike to -- to -- to plug.
And if that potential loophole does not exist though in the case of a discovery of a new basic invention, since “but for” the discovery, there would have been no income at all.
And accordingly, whatever income resulted is directly traceable to the discovery.
Thus, in this case, the Tax Court made findings of fact to the effect that Polaroid's income from the Polaroid Land Process during the tax year resulted entirely from its capacity to produce a picture in a minute.
If this process had not made an instantaneous positive print, this is the finding, there would have been no commercial demand for this camera or photographic fact during that period.
Now, with respect to the other discovery, the 3-D Synthetic Polarizer, the Tax Court found the exhibition of 3-D motion pictures would not have been commercially practicable, had petitioner's synthetic polarizers were not been available.
No, not infringing material for this practice was on the market.
So, there was no question of allocation.
This is brand new.
All the income proceeded from -- from the discovery.
It's not the type of thing that Mr. Barnett mentioned in his argument like giving allowance for the capital you have, the selling organization and so on.
Those things are involved in the sale of oil or the output of mines just as much is they are involved in the sale of a camera or a drug and so forth and they still continue to -- to be factors.
It have to be taken into account and the regulations so prescribe.
The regulation say, the present regulation say that you can attribute to prior years any income resulting some increased demand lessen competition and so forth.
So that it's recognized that there has to be some editing of the income based upon certain other factors.
In addition to that, as Your Honors remember I said yesterday, we have a stipulation here so that the Government and we have agreed as to how much of the income proceeded from the -- from these discoveries.
Now, the Government apparently acknowledges that ours is a type of case which considering the purpose of Section 456 would be entitled to relief but it answered unfortunately, we are one of the meritorious cases which was sacrificed in the interest of the administrative simplification.
We hope we are a meritorious case, but we are not one of those referred to in the Committee reports as having to be sacrificed.
The meritorious cases they refer to were cases in which a major portion of the income could have come from the improvement which resulted from the research and development.
But because of the inability to separate what income came from the improvement and what income was the basic -- came from the basic demand for the product that was the type of the case which had to be sacrificed.
No administrative discretion is involved in determining the income from a new basic discovery and Congress had no intention we submit of barring such a case from relief.
In other words, Congress indicated intent, plugged a loophole.
We can assume that it intended to do anything more than -- than what was necessary to plug that loophole.
And if Congress had any intent of eliminating from relief all industries other than the extractive industries, although those industries got relief under the two prior Excess Profits Tax laws, if it was making as drastic a change as that you would expect that it would have said something in its Committee reports in that connection, but it said nothing like it.
All it was doing was to plug a loophole with respect to certain cases involving research -- research and development.
And I might add that the word discovery does not necessarily presuppose research.
I don't imagine that Einstein's discovery of Law of Relativity required any research before it.
You could have discovery of a flower which would entitle to you a pattern which may or may not involve some -- some research.
So that our contention is if you -- if you have to read these Committee reports carefully that the -- the Committee reports indicate that -- that they're only taking out of the law what -- what was necessary to plug that loophole and that is accomplished by taking out what they put -- put into it and adding general research in 721 which hadn't existed in 1918 Act.
Now, before posing this point, I want to make one more observation.
The Government --
Justice John M. Harlan: Mr. Barnett, could I ask you a question?
Mr. Isaac M. Barnett: Yes sir.
Justice John M. Harlan: Do you draw the same distinction that Mr. Cummings does between basic inventions and other kinds of inventions?
Mr. Isaac M. Barnett: Yeah, we do Your Honor in this sense.
We -- we -- we feel that it has to be an invention which opened up a new field, created a new odd because that is a discovery.
And -- and words, there -- there are minor improvements which might positively entitle you a patent we don't regard as a discovery.
Justice Felix Frankfurter: You mean no antecedent, there must be.
It required that there was no antecedent to what your discovery had in demand.
Mr. Isaac M. Barnett: Well, Your Honor, at least Justice Taft referred to it as -- as substantially advancing the odds.
Justice Felix Frankfurter: That's what a patent is.
Mr. Isaac M. Barnett: Well, not -- not necessarily Your Honor.
Even in patent --
Justice Felix Frankfurter: It's necessarily to be a valid patent.
Mr. Isaac M. Barnett: Well, no.
Even in patents for example, you have some patents which they regard -- are regarded as substantially advancing the odd and there you get much more protection than one that's just a slight improvement which may technically be patentable.
Justice Felix Frankfurter: You mean some -- some applications are granted and some are not?
Mr. Isaac M. Barnett: No.
I mean on the law --
Justice Felix Frankfurter: Starting to get law protection from (Voice Overlap)
Mr. Isaac M. Barnett: Well, I will explain.
For example, supposing this was a basic invention, my spectacles, let's assume that and I've provided in my patent application that I used plastic.
If this was a basic invention, I would not only get -- get protection for spectacles made with plastic, I'd get it for anything that was its equivalent.
In other words I'd get it if it happened to be wood or happen to be any other substance whereas if this was just regarded, even though it was patented as just an ordinary invention, I would be limited to what I specified in the patent application.
If I said particular kind of plastic that's all the protection I would get.
So, what we are saying --
Justice Felix Frankfurter: That's just a wrinkle of the Doctrine of Equivalents?
Mr. Isaac M. Barnett: That's right, Your Honor and what we are saying is that you have to have an invention that substantially advances the odds to have this Doctrine of Equivalents.
You have to have in this case something that creates a new field.
Justice Felix Frankfurter: But I don't have to tell you that doctrine of equivalents in itself to do this doctrine or its application is, isn't it?
Mr. Isaac M. Barnett: There are quite a few cases on it, Your Honor.
Justice Felix Frankfurter: Quite a few cases and quite a few opinions too.
I mean, conflicting opinions.
Mr. Isaac M. Barnett: I'd like to say that's --
Chief Justice Earl Warren: Do I understand, Mr. Barnett that -- that your opinion within the case like we had the other day with that automobile top --
Mr. Isaac M. Barnett: That's right.
Chief Justice Earl Warren: -- which is not something that I assume you would call discovery that -- that if -- if their patent provided that it was metal and the metal and cloth can this that someone else could come along and use plastics and -- and plastics and aluminum and not be guilty of infringement.
Mr. Isaac M. Barnett: That is correct Your Honor.
Chief Justice Earl Warren: That is correct.
Mr. Isaac M. Barnett: Yes, Your Honor.
Now, I'd like to save a few minutes for reply but I just want to mention one thing else.
The government in its brief and it tries to make a point that it was really the mining industry that promoted Section 456 at the congressional hearing.
This doesn't happen to be so.
There were others interested in the relief provisions including one official of Polaroid who testified at those hearings.
But in the mining industry he wasn't particularly interested in Section 456.
The Government quotes a sentence from one of the spokesmen who said that the principle of Section 721 should be continued with revisions but the following sentence in his -- his testimony is this.
The special provision we recommend for allowance of a reasonable profit per unit of output may make Section 721 unnecessary, but many of the mining cases which would otherwise fall under its provisions, but there still seems to be a need for Section 721 as applicable to other cases.
The mining industry really didn't care about 456.
They were interested in the excess exempt output -- exempt excess output sections, the strategic minerals material section and so forth.
And in essence, that was what they were after and they got it in other sections of the -- of the law and I'd like to have whatever I have left as a reply Your Honor please?
Chief Justice Earl Warren: I'm afraid your time is up, Mr. for the red light.
Argument of Wayne G. Barnett
Mr. Wayne G. Barnett: Mr. Chief Justice, may it please the Court.
Let's say we agree that there is a difference in degree in the quality of inventions.
Some are major and some are minor.
We don't quite understand where the definition of discovery comes from that would include one and not the other.
The difference is not that one is whether something has been discovered; the difference has been what has been discovered.
You discover more, you discover less, but they are both equally discoveries in the dictionary sense of discovery.
The important thing though I think is that there is no basis in the legislative history of Section 456 for thinking that Congress was concerned with the difference as to the difference in degree between big inventions and small inventions.
The administrative difficulty that explains why Congress took out the statute research and development is not in distinguishing kinds of inventions.
The taxpayer says that if you have a new product, all of the income from its sale would not exist but for the invention.
Of course that's true in a “but for” sense.
The “but for” causation is not the same as how you allocate the income.
In the first place, I think the Polaroid camera is a good example.
It's relatively expensive item and it presumably would appeal only to people who are relatively affluent and to the extent that the stimulus to the war time economy added to the disposable income, it also added to the demand for the camera.
More importantly, however, the demand for a new product is not readymade.
You have to make a demand and the way that you create a demand is by advertising and that's the way Polaroid created the demand for its camera.
Now, quite apart from those factors certainly some of the income realized is simply the income from manufacturing.
If you -- if you manufacture and sell even a non-patented item, you usually make a profit, so that you cannot say that all of the profit is attributable to the value of the invention.
That is the royalty element of the profit.
You would have to segregate out of the sales income, a constructive royalty as it were, that you would attribute as being due to the value of the patent.
You would have to allocate the rest of the income to manufacturing profit, sales promotion activities, return on capital and the investment.
You can't say that --
Justice Potter Stewart: I don't understand this argument which you're making in this case because of my understanding, which I get from page 9 of the petitioner's brief, there's no question here as to the amount of that abnormal income and the allocation of it --
Mr. Wayne G. Barnett: Yes.
Justice Potter Stewart: -- from -- in this case that you -- that you've just realted.
Mr. Wayne G. Barnett: That is correct in this case.
Justice Potter Stewart: But we're talking about this case.
Mr. Wayne G. Barnett: I'm addressing myself to the statutory interpretation problem.
Now as to the application here, the Government counsel entered a stipulation, stipulating the amounts of net abnormal income and the attribution to prior years.
I don't want to back out of that stipulation.
The stipulation is erroneous.
The stipulation is based upon the same erroneous theory that the taxpayer is arguing here namely that all income realized from the sale of the Polaroid camera is attributable to the value of the patent, none of it attributable to the manufacturing, to the capitals of the labor, to the advertising and promotional activities.
Now, I'm not asking to be relieved from that stipulation.
I don't know what caused Government counsel to enter it.
There may have been other reasons.
Justice Felix Frankfurter: Are you saying it doesn't bear on the construction of what is done (Inaudible)
Mr. Wayne G. Barnett: It is not there on the construction of the statute.
I'm trying to explain why Congress changed the statute from Section 721 and omitted in Section 456 research and development income.
Justice Potter Stewart: Now, as part of that explanation, you're urging to us the difficulty if not impossibility --
Mr. Wayne G. Barnett: Yes.
Justice Potter Stewart: -- of ascertaining the amount of abnormal income involved.
Mr. Wayne G. Barnett: Yes.
Justice Potter Stewart: And yet, in this very case, you and counsel for the petitioner stipulated as to those amounts.
Mr. Wayne G. Barnett: Yes.
Justice Potter Stewart: You didn't find it impossible to do so.
Mr. Wayne G. Barnett: We didn't find it impossible to do so because we proceeded on erroneous theory.
It is very easy -- it's very easy if you attribute all the income to the invention.
There isn't a problem of allocation.
The regulations specifically require that income from the manufacturer of patented item be allocated as between the manufacturing and other factors and the value of the patent.
That was under 721 under Section -- when this kind of item was included.
That's Regulations 112 Section 35.721-7.
And the way the regulations suggest doing it is in the case where the owner of the patent, not only manufactures and sells the item, but also licenses someone else to do it for a royalty.
In that case, you have a measure of the value of the patent and out of this own manufacturing income, you take in a part equivalent to the royalty and call that the income resulting from the invention.
Justice Felix Frankfurter: Are you saying that by virtue of this stipulation an atypical case is before the Court, namely, the case in which the inventor or the discoverer -- so we're taking the petitioner's point of view -- the discoverer finances himself, it is (Inaudible) expenses, is that you're saying.
Mr. Wayne G. Barnett: Well --
Justice Felix Frankfurter: I mean this is an atypical case.
Mr. Wayne G. Barnett: Yes.
If I accept this sti --
Justice Felix Frankfurter: But you must (Inaudible)
Mr. Wayne G. Barnett: Well, I -- no, no.
The stipulation --
Justice Felix Frankfurter: Are you just going behind the stipulation?
Mr. Wayne G. Barnett: Yeah.
The stipulation --
Justice Felix Frankfurter: -- in which your accounting difficulty doesn't arise.
Mr. Wayne G. Barnett: Yes.
That is right.
That is right.
But we did not stipulate that this qualified as an eligible class of income.
Justice Felix Frankfurter: No, no, no --
Mr. Wayne G. Barnett: And I'm really arguing to the question of eligibility.
Justice Felix Frankfurter: But your answer -- your implicit answer to Justice Stewart's question is we can't -- that this case doesn't undercut your argument that as a practical matter it is difficult to make these allocations --
Mr. Wayne G. Barnett: Yes.
Justice Felix Frankfurter: -- because this a -- this is a white throw.
Mr. Wayne G. Barnett: Yes, that's right.
I might say that all of the cases under Section 721 did involve manufacturers who were selling their own products.
You never had this royalty measured and in fact what the Tax Court ended up doing was expressly recognizing that the allocation was a matter of opinion and judgment and as a matter of fact admitted that no two people could ever agree on how you allocated it.
And the way it resolved the cases in practice was to end up with a conclusory finding of fact stating what the allocation is without attempting to explain how they arrived at.
And that -- that is what Congress meant when it said that it could not provide for relief for this kind of thing without an undesirably broad range of discretionary judgment.
Now, Congress also gave a -- and that's equally true if it's brand new product.
You still have that problem of allocation.
Congress also gave a separate reason, namely that, the need for relief for this kind of income was not as great as the need for relief for other kinds of income.
That appears in the Committee report at page 12 of our reply brief.
I would like to suggest why that is, why there is a less need for the relief.
The other classes of income, classes A, C and D, namely judgments, the sale of the invention itself or change of accounting method.
Now, those are all clearly one time transactions that are unusual in the life of the taxpayer.
I would say a lumping of income in one year of the events giving rise to which have nothing to do with that yet.
Now, the taxpayers claim that their equitable right to relief the justification for extended relief is just like that for oil wells included in class D and they make that similarity.
Now, because they're oil production, you do have a continuing production of income.
It isn't the one shot we see.
Now, the difference there, I think for justification for including minerals is that the taxpayer is using out a wasting asset.
He is selling off his underlying oil deposit.
Now, that's important for this reason.
If he greatly increased his production of oil during the excess profits tax years, he really wouldn't be better off because he wouldn't have that same oil to sell after the excess profits tax years and there would be a strong incentive for him to reduce his production during the excess profit tax years and save his oil until the excess profit tax was gone.
And I think that is essentially a justification for allowing this relief to the mineral industries.
Now in a case of invention of patent, you lose nothing when you produce more during the war years because the patent expires not over units of production, but over time and the more you produce, the more you can still produce more later, so they're very different in nature in that respect.
Now, more -- the other reason is this.
Most people who have research and development income are continually engaged in research and development.
This is not one item that they discovered.
Searle has very large research department.
Their business is developing new drugs and selling them.
That is also true to Polaroid.
And during the excess profit tax years, they were engaging in research and development and deducting the cost of research and development.
Now, to be logically consistent, if we were to throw back to the earlier years, the income resulting from the prior research and development, you ought to bring into the excess profit tax years the future income which results from the -- their research and development during the excess profits tax years.
Now, I think it's obviously not a practical thing to do and I think the Congress' solution was sound to treat research and development as a current item.
You take the income into account when you receive it and you don't try to trace each item back to the years in which it was developed.
Now -- so I think those are the two reasons why research and development income was taken out of the eligible classes in the Korean War law, both the administrative feasibility of segregating the income and the lack of a pressing and even say debatable justification for providing that relief.
Now, I would like to turn -- I would like to turn, if I may now, to the last sentence of Section 456 (a) (2).
This is the alternative argument that is made by both taxpayers, which I did not deal with yesterday.
We have set forth the section in a skeletal form on page two of our reply brief.
That's the one, the consolidated brief in 151 and 169.
It's in skeletal form to emphasize the provisions relevant to this question.
That is assuming that it is not within class B, they argue that they're entitled to relief under the last sentence of paragraph (2).
That sentence reads the classification of income of any class not described in subparagraphs (A) to (D) inclusive shall be subject to regulations.
Their argument is that that makes all income of whatever nature and of whatever kind eligible for relief.
Now, before I try to answer that argument, I would like to state what the significance of it is.
In terms, it is all inclusive.
It includes all kinds of income, but it doesn't do you any good to have to qualify as abnormal income unless there is a basis for attribution, a basis for attributing the income to prior years under subsection B.
Now, virtually the only kind of income that is not expressly provided for elsewhere in the statute for which there could be claimed a basis of attribution is research and development income.
So the net effect of their argument really is, the practical operation, to say that the last sentence brings back within the statute the very kind of income that Congress expressly took out of the enumerated classes.
Now, it may be that that's a necessary result of the last sentence.
I think it's a rather remarkable result and one that should be avoided if possible.
Turning to what the last sentence does mean, I confess that I have no easy answer.
There is no interpretation of the last sentence simply from the words that is consistent with the rest of the statute.
In order to give it a meaning, I would like to go through the exercise by first trying to show that the last sentence doesn't mean anything and then show how you can give it a meaning, which is consistent with the statute.
I would do that first just on the face of the statute and then show that under the legislative history that in fact got into the statute apparently by inadvertence.
And I -- after that, I will then try to say how we think you can read it to give some meaning to it.
Justice Potter Stewart: The basic point though is that it doesn't mean anything at all.
Mr. Wayne G. Barnett: Well, as I say, that's more of an exercise.
I don't think this Court will need to hold that to dispose of this case.
Justice Potter Stewart: Not (Inaudible)
Mr. Wayne G. Barnett: The reason I do that -- the reason I do that is to give me a license to force the words into another meaning because the interpretation I would suggest is --
Justice Felix Frankfurter: But it's a license instead of a duty.
Mr. Wayne G. Barnett: A duty, if you will.
Justice Felix Frankfurter: Yes.
Presumably, here is a measure that comes out of the Joint Committee, doesn't it?
Mr. Wayne G. Barnett: Yes, yes.
Justice Felix Frankfurter: Well it is about as trained as technical core of any Committee that Congress has?
Mr. Wayne G. Barnett: Well, I confess.
I don't understand what they did this time, but I will come to that.
Justice Felix Frankfurter: But it's true, isn't it?
Mr. Wayne G. Barnett: -- I will come to that.
Justice Felix Frankfurter: That is trained technically?
Mr. Wayne G. Barnett: Yes.
Justice Felix Frankfurter: As trained body of technical advisers of any committee, do you?
Mr. Wayne G. Barnett: Well, yes.
This Act was passed, however, I must say in very short order and it is perhaps unique in its complexity.
I don't think you can find another statute that is quite as involved in this and --
Justice Felix Frankfurter: But a number of senators were deeply interested in it?
Mr. Wayne G. Barnett: Yes.
Justice Felix Frankfurter: Presumably read it, presumably.
Mr. Wayne G. Barnett: Yes.
Well, I think you remember in (Inaudible) case, I think there was some evidence that not every part of the statute have been fixed up.
There are some discrepancies in the statute.
Justice Felix Frankfurter: Anyhow, they can't go on the assumption that it --
Mr. Wayne G. Barnett: Yes.
Justice Felix Frankfurter: -- didn't mean anything?
Mr. Wayne G. Barnett: Well, I still think it is a useful exercise however you come out in the end.
The last sentence is as I have said provides for the classification of income of any class not described.
Now, literally, that seems to provide for the classification of all income because all income is of some class and that's basically their argument.
We can concede that, that all income is of a class, but what happens to the class after you classified it.
Now, the last sentence doesn't tell you that.
You have to go back to paragraph one, which is the operative definition of abnormal income and paragraph one says that the term abnormal income means an income of any class described in paragraph two, not income of any class, but any class describing paragraph two.
And paragraph two starts out by saying that each of the following subparagraphs shall be held to describe a separate class of income.
And the last sentence says that the classification of income of any class not described in the subparagraphs shall be subject regulations.
So the last sentence -- income is not described and the definition of abnormal income applies only to income which is described.
And so that the last sentence literally, reading it very literally and I confess this is a very literal reading, the last sentence provides for classification that has no operative effect.
Now, to show how it got into the statute.
It must --
Justice Potter Stewart: It doesn't mean --
Mr. Wayne G. Barnett: Yes.
Justice Potter Stewart: -- there are two classes.
First, the class of income which in various aspects, various kinds of which are described in paragraph 2, A, B, C and D and the second class is those not described.
Mr. Wayne G. Barnett: Yes, yes.
But abnormal income is defined as including only the -- only income of any class which is described.
And so classes of income which are not described are not abnormal income.
So they are classes of income but they're not abnormal.
They're not eligible to qualify as abnormal classes.
Now, I don't expect anyone to be persuaded by this argument as a matter of statutory interpretation.
I just want to set up the problem in those terms.
Now, the way that last sentence got into the statute is this.
As I have said, 456 came from Section 721 of the World War II law.
In the 1940 Act, Section 721 was in very different form and was limited to the six classes of income.
It was revised in 1941 into the form that appears on pages six and seven of our reply brief.
You will note that there, the abnormal income is defined to me, income of any class includable in gross income, any class at all.
It is not limited to any class described in paragraph (2).
It means income of any class.
Now, with that definition of abnormal income, you have to provide for classification of all classes of income.
And so, there, paragraph (2) did define separate classes of income and after enumerating six classes provided for the classification of all other income.
Now, the important thing about the last sentence in Section 721 is that all it did was to provide for the grouping, the classification which items you put together and which of those classes, if any, were eligible for relief was determined by paragraph one and the reason why 721 was very broad in scope is because paragraph one defined abnormal income as meaning income of any class includable in gross income, all income.
Now, that's not quite as strange as it sounds because I have said -- said before, abnormal income, the test of abnormal income is only the first step and you then have to show that it is attributable to prior years.
The effect of this definition of abnormal income was to lead to the attribution requirements in subsection B, the function of limiting relief to the proper kinds of income, but there was no test in subsection A, no qualitative test of what is abnormal income.
Any income could be abnormal and that was the function of the last sentence, purely, the accounting breakdown of income into several classes.
We then come to the Korean War law.
The House Bill, where it originated repeated all the same language of Section 721, including the unlimited definition of abnormal income in paragraph (1) as meaning, income of any class includable in gross income and therefore also the last sentence providing for the classification of all income.
The only change the House made in the bill from the predecessor bill was in the described classes, which were cut down to four classes and there was that change of the research and development was omitted.
Now, literally, if you read its bill literally, it really hadn't done very much because although it took research and development income out of the described classes, abnormal income wasn't limited to the described classes.
So the only defect literally was that research and development had to be put into another class, but which was equally eligible for relief.
Now, its report however, the report of the House Committee which is at page 12, I think obviously reflects that they have done more than that.
It states, after describing the kind of adjustment, adjustments of this type are limited to income arising out of at least the four classes.
It then has the discussion that I have talked about earlier saying why they have deleted research and development.
And they don't speak of deleting that simply from enumerating classes to put it some place else.
They end up saying that's why that item has been omitted from the list of abnormal types of income for which a reallocation can be made under this bill.
So the report clearly speaks as though relief were limited to the four classes and none other.
And by taking research and development out of the enumerated classes, it thought it was denying relief altogether.
Whereas I say, the bill didn't say that.
The bill had the same language that'd been put in, in 1941 for the very purpose of extending relief beyond the enumerated classes.
Now, when the bill got to the Senate, the Senate was faced with a choice whether they wanted to agree with the House Report or with the House Bill, because they were very different things.
And it shows the House Report and agreed with the report, it adopted the report verbatim, but it amended the bill to make the bill conform to the report and they did that by two amendments.
Amendment Number 200 inserted in paragraph one the phrase described in paragraph two so that an abnormal income was defined as income of any class described in paragraph two, which meant the quantitative test.
Now -- I'm sorry -- which meant the quantitative test.
There's always the quantitative test.
After you establish eligibility, you have to estab -- meet the quantitative test.
Now, since it limited the definition of abnormal income to the described classes, the last sentence providing for the classification of other income was unnecessary, so it deleted that sentence in Amendment 201.
Now, at that point, the bill said exactly what the Committee report said and everything was very clear.
Then the bill went to the conference and in conference, what happened -- the result of what happened is very clear.
The conference accepted the Amendment to the definition of abnormal income limiting it to the classes described in paragraph (2), but rejected the Amendment striking the last sentence.
Justice Felix Frankfurter: Or they allowed and retained what the House had?
Mr. Wayne G. Barnett: Yes, yes, yes, yes.
So that --
Justice Felix Frankfurter: In other words, the Senate -- the House did not recede on that --
Mr. Wayne G. Barnett: The House did not recede on that Amendment.
So that the effect is that we ended up with -- and the bill was passed in its form, we ended up with a bill with one Amendment to the definition of abnormal income which literally made the last sentence surplusage but they kept the last sentence.
Now, I don't know why the Conference Committee did that.
I don't think anyone else knows why they did it.
I think it is inconsistent action and I think to give -- if you read the last sentence, the way that the taxpayers suggest it should be read, you deny all effect to the addition of the limitation described in paragraph (2) --
Justice Potter Stewart: The last sentence of paragraph (2).
Mr. Wayne G. Barnett: Yes, it is a classification provided for in paragraph (2).
I agree with that, but certainly the author of the words described in paragraph (2), that is the Senate, meant by that the classes described in paragraph (2) and literally, the last sentence says provides for the classification of any class of income not described.
So it uses the same word described, it says not described and I think one or the other of the provisions doesn't fit, that they don't belong together.
Now, the simplest thing to do is to say that Congress just slipped out and you ought to read it literally, you read it literally.
The last sentence doesn't have any operative effect and so you ignore it.
Now, you don't have to do that.
How do you give meaning to the last sentence?
The taxpayer says that our reading of the last sentence results in our reading the same language in two Acts, the World War II Act and this Act to mean different things.
That is not quite right because if you read the last sentence to mean exactly the same thing that it didn't mean in 721, it would mean nothing because all in that in 721 was accounting and it didn't say -- it was not the last sentence that said that the resulting classes were eligible, it was paragraph (1) that said that and there is a different paragraph (1) and it's really from paragraph (1) that we derive a different ultimate effect of the last sentence.
Now, since read isn't a classification provision alone, the last sentence doesn't do anything.
You have to really read it as also not only providing for classification, but somehow providing that the resulting classes are to be eligible to qualify as abnormal income.
And our interpretation ultimately amounts to reading it as though it said not with the classification of any class of income not described through its sets of regulations, but as though it said the eligibility of any class of income not described in the regulations, in the subparagraphs shall be subject to regulations.
That is to say the secretary has a discretionary power to prescribe specific additional classes which shall be eligible for relief.
Justice John M. Harlan: That's the way the First Circuit read it?
Mr. Wayne G. Barnett: The First Circuit read it that way.
That is right and essentially, that is the interpretation given to it by the regulations although I think actually the regulations are somewhat at least (Inaudible) worded to leave open the possibility that there is no such thing as an additional class of income.
Justice Felix Frankfurter: And is that consistent with the way they measure that for the Senate?
Mr. Wayne G. Barnett: The way the -- that is consistent with Senator George's statement on the floor of the Senate which he said that the effect was to authorize the secretary to prescribe additional classes of income.
That is also the effect given to it by the staff of the joint Committee on internal revenue, still treated in relief as limited to define classes, but with some discretion, the commissioner or the secretary to add classes.
So it doesn't --
Justice Felix Frankfurter: That is not uncommon, is it?
Mr. Wayne G. Barnett: No, no, it is not.
Justice Felix Frankfurter: You had it (Inaudible) legislatively phrased classification --
Mr. Wayne G. Barnett: Yes.
Justice Felix Frankfurter: -- with power on the part of the secretary to contract or expand.
Mr. Wayne G. Barnett: Yes, that's right and I think that really is the way the regulations have interpreted and the regulations have specifically excluded and denied relief to research and development income.
Justice Felix Frankfurter: Before you sit down, Mr. Barnett, you just quoted Senator George and your name's sake led me to the congressional record.
Mr. Wayne G. Barnett: Yes.
Justice Felix Frankfurter: Now, what do you say to the exchange to which he referred between the Senator from Georgia and the Senator from Colorado (Inaudible) Senator George?
I don't - I am going back, but I gather that Senator Georgia was not in charge of the bill, that the bill was in charge of Senator Harrison.
Mr. Wayne G. Barnett: I informed --
Justice Felix Frankfurter: As chairman of the Finance Committee?
Mr. Wayne G. Barnett: Yes, yes, I've informed that's right for my authority.
Justice Felix Frankfurter: So that -- it would, Harrison, the authoritative spokesman and I myself and -- we can say constitutional as a matter of experience leery of quick answers by senators to accommodate some senator and for some reason to satisfy, but it does interest me that it was Mr. Adamson who said I'm not speaking out alone of mining company, it could apply equally to an inventor.
Mr. Adamson of Colorado was of course was chiefly in dispute in the mining industry of (Inaudible) and Senator Georgia that replies to all.
Now, it makes a difference to me, whether Georgia was in charge and Georgia was the spokesman for the measure or wasn't.
I gather he wasn't.
Mr. Wayne G. Barnett: Yes.
Justice Felix Frankfurter: This is an opinion.
What I'm suggesting is you can rely on Senator Georgia on one aspect of the case and then you grate his authority in another aspect of the case.
Mr. Wayne G. Barnett: Right, right.
Well, I am --
Justice Felix Frankfurter: Consider that colloquy (Inaudible)
Mr. Wayne G. Barnett: I'm not --
Justice Felix Frankfurter: And --
Mr. Wayne G. Barnett: Yes.
I'm informed that was the World War II Law which did include research and development income.
That was --
Justice Felix Frankfurter: (Inaudible) he is talking about this bill.
This bill and some of its provisions give him a chance to build up for better days of more accurate days and it's also gets for the corporation of the option of the term makes it turn to Texas, that Senator Texas finally (Inaudible) the obligation.
It is a rapidly growing (Inaudible) very great benefit particularly to companies which are rapidly growing, companies which is more or less speculate in their operation (Inaudible)
Mr. Wayne G. Barnett: Mr. Justice, are you reading from 87 congressional record?
Justice Felix Frankfurter: I'm reading March 3rd, 1941.
I believe it is.
Mr. Wayne G. Barnett: 1941.
That's the World War II Law.
That's the World War II Law.
We're into the Korean War Law.
That was the provision that did expressly provide for research development.
Justice Felix Frankfurter: So that was left out and --
Mr. Wayne G. Barnett: And that provision was left out of our provision.
Justice Felix Frankfurter: Senator Georgia's answer is any (Inaudible) goes the other way.
Mr. Wayne G. Barnett: Yes.
Yes, that's right.
We admit this would have been covered under the World War II Law.