UNITED STATES v. SKELLY OIL CO.
Legal provision: Internal Revenue Code
Argument of Erwin N. Griswold
Chief Justice Earl Warren: Number 280, United States, petitioner versus Skelly Oil Company.
Mr. Solicitor General.
Mr. Erwin N. Griswold: Mr. Chief Justice and may it please the Court.
This is a federal tax case here on a writ of certiorari from the United States Court of Appeals for the Tenth Circuit.
Although it is a tax case, it is a sequel or consequence of a decision rendered by this Court in 1958 in Wisconsin Pipeline Company against the Corporation Commission of Oklahoma where this Court held that the Corporation Commission of Oklahoma had no power to fix minimum rates for the sale of gas.
The respondent taxpayer here produces and sells natural gas.
During the years 1952 through 1957, it charged its customers, those increased rates pursuant to the order of the Oklahoma Corporations Commission.
Naturally, the amounts which it received were income to it.
They entered into the computation of the “gross income from the property” against which it took in each of those years, 1952 to 1957 a deduction of 27.5% as percentage depletion pursuant to Section 613 of the Internal Revenue Code.
There's no doubt that it was entitled to this deduction for depletion as it clearly receive the gross income under a claim of right that the statute provided that where income is received from oil and gas, there is a depletion deduction.
A taxpayer has his option to take either cost depletion or percentage depletion.
In this case, percentage depletion was advantageous and that was what was taken.
Following this Court's decision in the Pipeline case, and the respondent was sued by several of its customers on the ground that they had been overcharged.
And it promptly having no defense to that case in 1958, it settled that controversy with two of them and paid to them an aggregate of $505,536.00 in 1958 and it is the company's tax year 1958 and only that year which is before the Court.
The question is the consequence or the way in which it should be treated of that repayment made in 1958.
The taxpayer deducted the repayment in full.
We say that the deduction allowed in 1958 should be reduced by the amounts previously allowed as deductions for percentage depletion in the years 1952 through 1957, that is by 27.5% and that is the issue to which I will return after the recess.
Chief Justice Earl Warren: We'll recess now.
Mr. Erwin N. Griswold: As I was saying before the recess, this case involves two payments aggregating $505,000.00 made by the respondent in 1958 which represented repayments of excess charges for gas which it had sold in the years 1952 through 1957 for which it had received payment and against which payments it had deducted the statutory percentage depletion in the amount of 27.5%.
Taxpayer's contention is that it is entitled to deduct the entire amount of the repayments made in 1958 despite the fact that depletion had already been deducted with respect to them.
There is some discussion in the briefs as to whether this deduction is under the deduction for a loss or the deduction for business expense as suggestion made that the Government has changed its ground on that.
I do not think that that is the case.
The stipulation in the matter on page 18, the last line of the page in the appendix simply says that they took a deduction but I spend no time on this because I do not think it is important or of any consequence in any event.
The District Court agreed with the Government's argument and entered judgment for the Government based on the position that the deduction for 1958 should be reduced by the amount of percentage depletion which had already been allowed as a deduction with respect to the payments.
On appeal, the Court of Appeals for the Tenth Circuit reversed.
It then granted the Government's petition for rehearing but after the rehearing, the Court adhered to its earlier decision by a two-to-one vote, Judge Hill writing an extensive dissenting opinion.
Now, with respect to the law, I think that it can fairly be said that what is really involved here is basic questions of proper tax accounting and it was because of the undesirability of having clear principles already established by this Court made confusing that we felt that it was important to seek a review here.
The case also involves Section 1341 of the Internal Revenue Code and I'll turn to that in a moment.
I think it's fair to say though that even though Section 1341 must be considered, the proper conclusion is that on consideration, one could come to the conclusion that Section 1341 is in fact bypassed in this case and that the case should be decided exactly as it would be decided if Section 1341 had never been enacted.
Now, the relevant portion of Section 1341 is set out on pages 10 and 11 of our brief.
It is also in the appendix to both briefs of elsewhere but looking at page 10 of the Government's brief, we find that it starts out with if and then there are five numbered paragraphs.
The first three are conditions to the application of the section and I would point out that paragraph 1 says, if an item, and I would call attention to those words, “an item was included in gross income for a prior taxable year or years because it appears that a taxpayer have an unrestrictive right to such item.”
Now that's the payments which the respondent receives in the year 1952 to 1957.
Two, a deduction --
Now, I call your attention to the fact that that is not the same word.
It is a different word.
It does not follow that the deduction is in the same amount as the item.
The deduction is whatever is the appropriate amount of deduction.
In the light of the fact that an item was received “a deduction is allowable for the taxable year because it was established after the close of such prior taxable year or years, that the taxpayer does not have an unrestrictive right to such item or to a portion of such item” and that condition is met here.
And three, “the amount of such deduction exceeds $3000.00.”
That condition is met.
Then the tax imposed by this chapter for the taxable year shall be the lesser of the following and now there are the two-numbered paragraphs 4 and 5.
I think it's convenient to say the taxpayer has his option of proceeding under one or the other.
Actually, the statute says that the tax shall be the lesser of these two.
Four, the tax for the taxable year computed with such deduction and you'll notice, the deduction goes back to the item in the word in paragraph 2 or 5, and 5 is barely long but it says, in substance that the other matter which is to be computed in determining which is the lesser is in effect to take the amount out of the prior taxable year reducing the taxes for this year by the taxes which were as it now develops improperly paid in the earlier year.
Now, the fact is that Section 1341 (a) (5), the language on page 11 of the Government's brief was not utilized by the taxpayer here.
This case arises with respect to Section 1341 (a) (4) which provides the tax for the taxable year computed with such deduction is the amount which is to be taken into account and I suggest that that leaves the situation exactly where it would have been if Section 1341 had never been enacted because the tax for the taxable year would be computed with such deduction prior to the enactment of Section 1341.
The taxpayer here has simply found it desirable not to use the relief which Section 1341 provided through paragraph 5 because that would have been less advantageous to get at its claim under paragraph (a) (4) and interestingly enough, this was expressly recognized by the court below in its first opinion.
This is on page 42 of the appendix in Judge Seay's opinion beginning the first full paragraph on that page, “Thus, it appears that Congress by Section 1341 enacted the existing rule as to current year deductions and added another provision.”
But 1341 (a) (4) is simply the existing rule, the rule that would have been applicable if 1341 have never been passed and then later in the same paragraph, a little below the middle of the paragraph, “Thus, it must be concluded that Congress sought to make no change in the current year deduction remedy but only added the recomputation provision.”
And in our view, the court was thoroughly sound in saying that but simply did not pursue it through to its conclusion because the majority of the court below reached its result in effect by construing Section 1341 and saying that the word deduction in those several provisions must be read as having the same meaning as the word “item” in paragraph 1.
Justice Byron R. White: Mr. Solicitor General, is the law clear that if the other alternative had been used namely recomputing the prior years tax that in computing that tax, you would have just excluded the item of income but still retain the depletion and deduction?
Mr. Erwin N. Griswold: Well, Mr. Justice, I think it is clear and I hope that it will be after this Court has decided this case.
Justice Byron R. White: But you mean, it isn't clear under that other --
Mr. Erwin N. Griswold: At the present time, it is somewhat clouded by the decision of the Tenth Circuit but --
Justice Byron R. White: But that is under a different way of approaching, is it?
I mean, let's say, at least it -- you say, there are two ways of approaching it.
The taxpayer had no alternative and it didn't choose the recomputation route --
Mr. Erwin N. Griswold: It didn't choose paragraph 5 --
Justice Byron R. White: That's what I mean.
Mr. Erwin N. Griswold: -- which would have meant throwing it back into the earlier year and reducing the tax for this year by the amount of tax which it paid.
Justice Byron R. White: If it had done that though, would you say the law is unclear that in so doing, all it would have done was to exclude the item of income to the prior year?
Mr. Erwin N. Griswold: No, Mr. Justice.
Paragraph 5 might have been very advantageous to them suppose for example they have had a lost in 1958 then they would want to use paragraph 5.
Justice Byron R. White: Yes.
Well, they wouldn't have paid any tax at all.
Mr. Erwin N. Griswold: Suppose they had had a smaller loss or putting it another way, Section 1341 is very much a consequence of this Court's decision in the Arrowsmith case.
The Arrowsmith case involved a situation where the taxpayer received an amount in liquidation of a corporation in one year and returned that as income as a capital gain.
In a later year, it was required to make a payment with respect to that on the ground that it was a transferee from the corporation and the corporation owed money.
There was no suggestion that they were not entitled to deduct the amount in the later year.
The only question in the Arrowsmith case was whether the deduction was as a capital loss or as an ordinary loss and this Court held that since the repayment in the later year arose out of the capital transaction.
It was to be treated as a capital loss and that is a case which we think supports our position here but the problem which it presented was that capital losses are subject to superior restriction as to their deductibility and they might have included the amount in the earlier year in income be entitled to deduct it as a capital loss in the later year but get very little benefit from it, and it was for that reason that 1341 (a) (5) was enacted to say that if they got little benefit from it in the later year, they could reduce their tax for the later year by the amount of tax which they paid in the earlier year.
You also get similar situations where there are changes in the tax rates.
In this particular case, the tax rates were exactly the same in each year.
There were no losses that affected the situation, no carryover, so that the only reason the taxpayer wanted to use 1341 (a) (4) was because it thought as the Tenth Circuit held that such deduction in 1341 (a) (4) meant the same thing as the item or an item in 1341 (a) (1) and allowed the taxpayer to deduct the entire amount of the payment despite the fact that 27.5% had already been deducted with respect to the same payment.
Now, we contend that that is wrong as a matter of principle, that this is in the area of proper tax accounting long since established by decisions of this Court that Section 1341 was wrongly construed by the court below and that when it is rightly construed, it leaves the well-known decisions of this Court in full operation which would require the adjustment for which the Government contends.
Now, in some ways the closest of these cases is one that was decided long ago, United States against Ludey, decided in 1927, opinion by Mr. Justice Brandeis who had a very excellent grasp of the accounting background and problems in this area.
Brief for the United States was written in the time of Solicitor General Mitchell and I was much interested in reading that brief to find that the argument which he then made is essentially the argument which we are trying to present here and it is the argument which was accepted by the Court.
The Ludey case involves the determination of the amount of gain on the sale of a mining property.
It arose with respect to the year 1917 which was before there was any provision in the statute providing for the adjustment of basis of property on the sale of property.
The statute provided explicitly that the basis of property shall be its cost or its March 1, 1913 value.
In that case, the taxpayer had deducted the depreciation on its machinery.
It had deducted depletion with respect to its oil which had been taken out.
But when they came to sell the property, they computed their loss by taking the full cost with no adjustment for the depreciation and depletion which had been sustained and the Court of Claims supported the taxpayer in that and said that there was no basis in the statute for the adjustment.
There was some controversy as to amount of the adjustment if it was to be made namely whether it was the amount which the taxpayer had actually deducted or depletion and depreciation or whether the adjustment to basis should be the amount which they could have deducted if they had taken all that they could and should have taken and this Court in the opinion by Justice Brandeis and let me emphasize again without any explicit statutory provision, simply as a matter of general principles of tax accounting, held that in computing the gain or loss on the sale, the basis must be adjusted by the amount of depreciation and depletion sustained and remanded the case to the Court of Claims to determine that amount.
Now the next case chronologically which provides a part of this basis for determining sound principles of tax accounting is Charles Ilfeld Company against Hernandez in 292 U.S.
Now that is a case where a parent company had some subsidiaries and if filed consolidated returns with those subsidiaries.
The subsidiaries had losses in nearly all of the years involved and the effect of the consolidated returns was that the subsidiary losses were deducted against the parent's income which was entirely right and appropriate as the function of consolidated return.
But in the year 1927 which was involved in that case, the parent liquidated the subsidiaries and since the subsidiaries had had consistent losses, the parent got very little out of the subsidiaries when it liquidated them and it sought to deduct on its tax return the amount of the loss which it sustained on the liquidation of the subsidiaries.
Here again, there was nothing in the statute which dealt expressly with it.
There was a statutory provision giving the Commissioner broad power to make regulations in this area.
The Commissioner had made regulations but none of them really quite fit this particular situation and in the Ilfeld case, an opinion by Justice Butler, the Court held that the loss could not be taken because in the Court's language and this is quoted on page 19 of the Government's brief.
If allowed, this would be the practical equivalent of double deduction.
And that of course is exactly the situation which is involved here.
If the taxpayer here is allowed to deduct the entire amount paid in 1958, it will with respect to this transaction have deducted an aggregate of 127.5% of the amount paid because it has already deducted 27.5% as percentage depletion.
Justice Byron R. White: Is it also accurate to say that in effect the depletion which was actually taken in the prior year with respect to a certain amount of income from mining, if you then deduct some of the income in the later year and leave that depletion taken on the prior year, you will take any much higher percentage of depletion as against the remaining income?
Is that the same idea or not?
Mr. Erwin N. Griswold: Well that -- you can say in effect that they have deducted 27.5% twice with respect to the same mineral.
This is a little complicated to answer because we're dealing with percentage depletion.
It has nothing whatever to do with the amount that was lost where a cost depletion --
Justice Byron R. White: And the amount -- the amount of percentage depletion depended on what the gross income for mining was included in that return.
Mr. Erwin N. Griswold: Depended on what the gross income for mining was and we contend that the 505,000 repaid in 1958 reduced the gross income from --
Justice Byron R. White: And therefore, the depletion allowance, the prior return was unjustified.
Mr. Erwin N. Griswold: As it now turns out, the depletion allowance in the prior return was not justified.
However, under decisions of this Court like Arrowsmith, without Section 1341, you don't go back and correct the earlier year.
You make the proper correction in this year and we suggest that the proper adjustment is to allow the deduction the $505,000.00 paid less 27.5% percentage depletion which has already been deducted.
Justice Abe Fortas: Mr. Solicitor General, I hope you won't mind, I really have difficulty in understanding why 1341 (a) (4) is not controlling here.
It seems to me that that may to my mind at the moment, that's the central question.
I have difficulty with your suggestion that the court below construed the word deduction as meaning item in paragraph 1 because it seems pretty clear that deduction refers to paragraph 2 and paragraph 2 defines deduction whereas the amount that was deducted for the years 1952 for the repayment of payments received in 1952 to 1957 and if that is so, 1341 (a) (4) read simply and literally seems to say that for 1958, the tax would be computed with the deduction, namely, the deduction described in paragraph 2 which would mean the amount that this taxpayer had to refund to customers.
Mr. Erwin N. Griswold: Well, Mr. Justice that is pretty close to the taxpayer's contention in this case.
Justice Abe Fortas: Well, tell me what's wrong Mr. -- I didn't follow you really.
Mr. Erwin N. Griswold: It seems to me that the -- it seems to me to begging your pardon clearly wrong.
Justice Abe Fortas: Well, I know.
I want you to tell me why, explain.
It seems to me maybe that it is -- the result is a little startling to my mind but I'm not sure how you get around the statutory language.
Mr. Erwin N. Griswold: Well, let me just take the language.
1341 (a) (4), the tax for the taxable year computed with such deduction, that doesn't how much?
It just says “such deduction.”
That obviously refers back to 1341 (a) (2) as a deduction.
Justice Abe Fortas: And what is the deduction under (a) (2)?
Mr. Erwin N. Griswold: It seems to me that in the statement which you have made, you have taken the next leap which is to say that a deduction means in this case $505,000.00 and I suggest that there's nothing in 1341 (a) (2) which says that the deduction to which a deduction refers is $505,000.00.
Justice Abe Fortas: Well, of course, I might think $505,000.00 when I'm suggesting to you that in asking your help if this is not -- if you disagree with this as I gather you do and I don't understand why and therefore there's a word such deduction, two words “such deduction”, just reading this and literally it would seem to refer to subparagraph 2.
Mr. Erwin N. Griswold: Clearly, it does.
Justice Abe Fortas: And subparagraph 2 would mean as the amount $505,000.00 here, is that the amount of the overpayment?
Mr. Erwin N. Griswold: That's the amount of the overpayment.
Justice Abe Fortas: Well, it would seem to refer to that amount here.
Mr. Erwin N. Griswold: Well, Mr. Justice --
Justice Abe Fortas: But now tell me why it doesn't.
Mr. Erwin N. Griswold: Because I think that a deduction does not have the same meaning as the words “the amount repaid.”
It does not have the same meaning as the word “an item” in paragraph 1.
Now, the item was $505,000.00
Justice Abe Fortas: No, sir but --
Mr. Erwin N. Griswold: That was what was taken into income.
Justice Abe Fortas: I'm sorry Mr. Solicitor General but paragraph 2 defines a deduction as being the amount, an amount allowable for the taxable year because the taxpayer did not have an unrestricted right to such item or to a portion of such item.
Now, that here would be the -- as I read it literally, regardless of whether the results observed or not.
As I read it literally, that would seem to refer to this precise $505,000.00 and I still don't follow that.
Mr. Erwin N. Griswold: Only Mr. Justice if you take the position which I think is not warranted that the deduction referred to in 1341 (a) (2) is the same in amount as the amount of the item which was paid out and what I have been trying to suggest is that the amount of the deduction to which the taxpayer is entitled, under cases like Ludey and I repeat, I think Ludey is the closest case of all, is not the amount paid but is the amount which is properly deductible for the year.
Justice Abe Fortas: Well, I beg your pardon sir but if you will bear with me a moment, you look at (2), that defines for purposes of 1341 what is meant by the Congress by the allowable deduction and it defines it as I read this as the amount to which the taxpayer did not have an unrestricted right.
Mr. Erwin N. Griswold: I think you shortened the language and perhaps unduly.
Paragraph 2 says, a deduction, nothing there had to indicate how much the deduction is.
Justice Abe Fortas: Well go on and you have to read the whole paragraph.
Mr. Erwin N. Griswold: Well, I'm trying -- what I'm trying to suggest that a deduction is colorless as to the amount.
A deduction, whatever that amount is, and we contend that it's the amount paid less 27.5%.
A deduction is allowable for the taxable year because it was established after the close of such prior taxable year or years that the taxpayer did not have an unrestricted right to such item.
Now item is not the same thing as --
Justice Abe Fortas: Now, to what did the taxpayer here not have an unrestricted right?
To what amount?
Just give it to me, simple.
To what amount?
Mr. Erwin N. Griswold: $505,000.00.
And that is the item but our position is that Congress says, deliberately used different words and that “deduction” is a different word than “item” and that we still have left to determine what is the appropriate amount of the deduction and on that I suggest that the Ludey, Ilfeld, and Arrowsmith cases appoint the way.
Justice Potter Stewart: I think your point is, Mr. Solicitor General, that subsection 2 here is not a definition of the amount of the deduction.
Mr. Erwin N. Griswold: Exactly, Mr. Justice.
Justice Potter Stewart: That's where you and Justice Fortas find yourself --
Mr. Erwin N. Griswold: That's exactly the point that I'm concerned, that I have not able to make my position thoroughly.
Justice Abe Fortas: Well, what is its function though?
Could you help me there?
Tell me, what is its function?
Justice Potter Stewart: Or the conditions.
Justice Abe Fortas: What is the function of the verbiage of subsection 2 if it is not to define the amount which the taxpayer may deduct in the defined circumstance?
Mr. Erwin N. Griswold: It is to define the one of the three conditions upon which Section 1341 becomes operating.
Justice Abe Fortas: You mean it defines the circumstances that is to say, if you find that the taxpayer did not have an unrestricted right to the item that he included in his income in a prior year.
Mr. Erwin N. Griswold: Then a deduction.
Justice Abe Fortas: Then you go to look -- then he's entitled to a deduction?
Mr. Erwin N. Griswold: Right.
Justice Abe Fortas: And then you find out what the amount of the deduction is not by reference to the amount to which he did not have an unrestricted right but by reference to the existing case law.
Mr. Erwin N. Griswold: That is exactly our position.
Justice Abe Fortas: Thank you.
Justice Byron R. White: In fact, the taxpayer never did pay taxes for the previous year on entire amount of the item.
Chief Justice Earl Warren: No, Mr. Justice he paid taxes on the entire amount less 27.5%.
Chief Justice Earl Warren: Mr. Casey.
Argument of Robert J. Casey
Mr. Robert J. Casey: May it please the Court.
I think that this present discussion points out exactly the problem between the Solicitor General and myself.
The deduction allowable under Section 1341 (a) (4) is in fact described in 1341 (a) (2).
It is the amount which was included by the taxpayer in gross income in the year of receipt.
We agree with the answer to Mr. Justice White that in fact the taxpayer had a percentage depletion allowance but with respect to this $505,000.00 and therefore the $505,000.00 did not drop down in tax into taxable income.
That is true but 1341 says it is the amount included in gross income which prevails.
Now, we have heard arguments here looking to the Ludey and Ilfeld cases which further point out the problem which percentage depletion introduces into this specific area.
Mr. Justice White asked a question which I thought was going to lead to a discussion of whether there is any given amount which will be recovered from a mineral property and my answer to that would be if the question were ask to me, no.
There is no amount to be recovered.
Now, we were -- our attention was directed to the Ludey case where there was in fact a specific dollar basis for property.
Ludey dealt with the cost --
Justice Byron R. White: Could I ask you that if this so-called item had not been included in the previous year's income, would your percentage of depletion taken in that year have been the same?
Mr. Robert J. Casey: No, sir, it would not.
Justice Byron R. White: It would have been 27.5% of the item left?
Mr. Robert J. Casey: Yes, sir.
That is absolutely true.
Justice Byron R. White: Yes.
Mr. Robert J. Casey: But the problem which that question brings in is in fact the finally determined principles of tax accounting which this Court has laid down, that is the annual accounting concept.
Justice Byron R. White: Well, you think Congress actually thought in these terms and decided to leave, to give a full deduction for the item and leave the depletion in the previous year intact?
Mr. Robert J. Casey: I can't tell you that Congress was looking specifically to a depletable income item but I can tell you that in their own words, Congress said, “If the item was included in gross income.”
Justice Byron R. White: Well, you see -- but you think in fact that they used these words construed as you say they should be construed as you say they should be construed that it actually have in mind the situation before the Court?
Mr. Robert J. Casey: It's typical for me to imagine that this would have escaped the attention of the Congress.
Now, when 1341 was passed by the House, it did not include the exception that brings us here under its umbrella.
Justice Byron R. White: But you don't think it's surprising that Congress would say you may reduce your income in effect the previous year without reducing your depletion.
Mr. Robert J. Casey: I think that that is the office of percentage depletion.
The difficulty that we have in applying Ludey and Ilfeld to this case is that we in this case talk about two separate and distinct deductions.
The deduction with respect to percentage depletion which occurred in the years 1952 to 1957 had to do with a recovery of the taxpayers' interest in the mineral property.
It is admitted that the mineral was severed and sold in those years and that in fact the property was depleted.
Now, Congress has told us how to measure that year's depletion of the property for purposes of Section 613 and they have said it very clearly and the distinguished Solicitor General has agreed that as of the facts known at the end of each of the years of receipt, the percentage depletion allowance claimed and allowed to the taxpayer was proper.
Justice Byron R. White: What would happen if you had elected to use (a) (5)?
Mr. Robert J. Casey: Well, to --
Justice Byron R. White: Then you would have recomputed your tax to the prior year, wouldn't you?
Mr. Robert J. Casey: We would have recomputed the tax for the prior year solely by excluding the amount from gross income.
Justice Byron R. White: And you don't think you would have any change your depletion deduction?
Mr. Robert J. Casey: Well, this case isn't before us but in my opinion, no we would not because percentage depletion is predicated upon gross income from the property which is an entirely different concept from gross income.
Justice Abe Fortas: Well if you had made the refunds in the same taxable year, then you would not have gotten the benefit of the depletion allowance on those, isn't that right?
Mr. Robert J. Casey: That is exactly right.
Justice Abe Fortas: And isn't it a little bit difficult to think that Congress really intended to establish a different rule just because the refunds were made in a subsequent year?
Mr. Robert J. Casey: I don't think so.
This Court had --
Justice Abe Fortas: But you can't?
There isn't anything in the legislative history that I've noticed in your brief.
Mr. Robert J. Casey: Well, we know that Congress enacted Lewis and Healy, they codified it.
This is the annual accounting principle which says that as of the end of any given taxable period, the taxes imposed regardless of advantage or disadvantage of either the Government or the taxpayer.
Now, we also know that there are other areas where the time sequence has to some taxpayers and sometimes to the Government disastrous results.
The Gordon case which this Court decided in the fall I believe.
If the distributions involved in the Gordon case had taken place within one calendar year, the distributions would have qualified for tax free treatment under the code but a time factor fell the end of the taxable year.
There were distributions made in separate years and the tax results were disastrously different for the taxpayer.
This is the problem which is always in here in the annual accounting method.
It always has been the subject of conjecture whether we wouldn't all be better off using a transactional or an open account approach to tax computation.
But this Court has decided in (Inaudible) that the needs of the Government for annual income preclude that.
Now, it is not unusual.
In fact, it is rather usual and it is what prompted the enactment of 1341 that when a taxpayer receives claim of right income which and is required to restore it in a context where in fact he incurs a deductible expense.
The deductible expense incurred in this case in the year 1958 which as the Solicitor General said is the only year before the Court, was not percentage depletion expense.
It was the payment of a lawsuit of the damages and litigation, the settlement of a lawsuit.
Now, if you look at the settlement of a lawsuit.
Justice Byron R. White: Do you think it really (Inaudible)?
Mr. Robert J. Casey: If it had been -- well, it's hard for me to address myself to that.
Justice Byron R. White: Well, as always then, would you think for an allowance is based on the amount by which, physically a (Inaudible).
Mr. Robert J. Casey: No sir.
You shouldn't compute it that way because that is not the thrust of the percentage depletion allowance.
Justice Byron R. White: Well, I know but you are asking me to compute as though the percentage of the depletion allowance was a fixed amount based upon say the tonnage or the gallons?
Mr. Robert J. Casey: Now, that is not my position and I hope I have not left you with that impression.
I am saying that this taxpayer incurred a business expense in the years 1952 through 1957, that is the reduction of his mineral property by reason of the severance and sale of the mineral.
That that deduction in those years was computed not on a basis of the taxpayer's cost, not on the basis of a discovery value, but on ad hoc formula basis which the Congress has proposed and the Congress has said that you take 27.5% of your gross income from the property limited by 50% of your taxable income from the property.
That is a separate and completely different business expense from the settlement of the litigation which occurred in the year before this Court.
Justice Byron R. White: But again, Mr. Justice Fortas suggested that this settlement been paid at the year your income defining what it had produced?
Mr. Robert J. Casey: Yes, sir.
Justice Byron R. White: And your depletion?
Mr. Robert J. Casey: Yes, sir.
Chief Justice Earl Warren: Mr. Casey, do you believe if this matter had been specifically presented to the Congress that the Congress would have said in these circumstances, you are entitled to take a double 27.5% depletion allowance?
Mr. Robert J. Casey: Well, I don't think Mr. Chief Justice that we can assume for a minute that Congress was unaware of this possibility.
Chief Justice Earl Warren: No, I didn't ask you that.
I asked you if it had been specifically presented to them and discussed in their committees.
So do you think that they would have arrived at any such conclusion?
Mr. Robert J. Casey: Well, yes I do.
And number one if I could --
Chief Justice Earl Warren: Would you tell me why they would give 55% deduction in circumstance of this kind?
Mr. Robert J. Casey: If I could amend the question to be asked of the Congress not to say would you allow a double percentage depletion allowance because they haven't.
We have taken one percentage depletion allowance in each of the years at the receipt the money.
Now, that percentage depletion allowance came to us not because of a successful lawsuit, not because of any other business operation except the severance and sale of our mineral.
Now, clearly, Congress had before it the right to do what the Government would propose in this case and that is, equalize the tax.
If all it wanted to do was to make the parties whole, it had in fact before it a Court of Claims decision which have been decided in 1953 in the Perry case in which the Court said the only fair way to handle manners of this kind is to go back to the year of receipt and recompute the tax and that's the measure of the deduction in the current year.
It had before it the possibility of not allowing the Government or the taxpayer to take potluck to go with the Healy and Lewis rules which said no matter what happened in the year of receipt, no matter what tax benefit you had, we are going to strike the balance in the year of restoration and if it's a disadvantaged to either side, that's the way it's going to be but they didn't do that.
They said --
Chief Justice Earl Warren: I just like to ask you this.
By amending the question that I asked you, does that lead you to the conclusion that this is not a double taking?
Mr. Robert J. Casey: Yes indeed, it does sir.
Yes, it does because what the Government would propose to do here is take dollars which this taxpayer garnered in the ordinary course of its business and traced those dollars to the settlement of a lawsuit which took place in some instances six years later.
Justice Byron R. White: Now, what does your -- what was this deduction amount to the current year, $505,000.00 for your --
Rebuttal of Erwin N. Griswold
Mr. Erwin N. Griswold: We deduct it from ordinary income.
Justice Byron R. White: Gross income?
Mr. Erwin N. Griswold: From gross income.
Justice Byron R. White: Well, they then should deduct it from gross income from mining for the current year?
Mr. Erwin N. Griswold: I don't think it's properly deductible from gross income from mining.
Justice Byron R. White: If it were, why you would have to make your percentage depletion as we have here.
Mr. Erwin N. Griswold: Yes, it would.
But of course it isn't really an expense of the current year's operation of that particular property.
Justice Byron R. White: So that I suppose if you were permitted or required deducted income for mining this year, you would have the same effect roughly that the Government's interest.
Mr. Erwin N. Griswold: Not -- well, I guess the quick answer is yes.
It would reduce the current year's percentage depletion yes sir but --
Justice Byron R. White: But accounting wise you may not do that in this year or you don't want to do it?
Mr. Erwin N. Griswold: Well, accounting wise it really isn't a factor that goes to bringing gross income from the property down to taxable income from the property.
It's an expense of the business generally, the settlement of a lawsuit just like compensation to central --
Justice Byron R. White: In this particular case, the year, the way you deducted it in 1950 taxes did not really reduce incoem from mining, income from the property at first (Inaudible) depletion in 1958.
Mr. Erwin N. Griswold: That's true.
That's right, yes sir.
Justice Abe Fortas: And you would not welcome that suggestion?
Rebuttal of Robert J. Casey
Mr. Robert J. Casey: Well, I would resist it if I could but I don't think that it is really a proper charge against that -- the operation of that property.
I also would suggest that if Congress wanted to put the parties back where they were without the receipt and restoration that it could easily have done so.
It's very difficult for me to see how an argument can be made as the District Court found in this case that all Congress wanted to do was equalize the tax burden because it specifically requires that the current year's deduction as in Lewis and Healy or the recomputation of the prior year's tax occasion solely by excluding the amount from gross income.
It gives the taxpayer the better of those two worlds.
Justice Abe Fortas: Is there -- may I ask you Mr. Casey, Solicitor General has for the moment in a way clarified my view of the meaning of subparagraph 2.
Now is there anything that you want to say about that?
In other words, the Solicitor General now has explained to me that paragraph 2 states the circumstances in which the deduction may be allowed but it does not purport to describe or define the amount of the deduction.
Now, do you, I take it, do you disagree with that?
Mr. Robert J. Casey: Yes, I do.
Justice Abe Fortas: And is there any authority one way or the other or what do you have to say about it?
Mr. Robert J. Casey: Well, when you look to deductions as the Government's brief in this case, no.
You can't take a deduction for an item unless you have included it in gross income.
The three 1341 case law was clear on that.
There was a suggestion in a tax court case that perhaps taxable income might be the criteria.
In other words, a tax benefit rule with a benefit running to the government and it is our position that 1341 makes it perfectly plain that the basis for the deduction here is only inclusion of the item in gross income the fact that that inclusion gave rise to a tax is immaterial.
The fact that the inclusion and gross income was the Government's reward from that inclusion was derogated from because of deductible expenses is immaterial.
We feel that 1341 tells this specifically.
If an item is included in gross income, if the repayments of that item in the subsequent year is a deductible event as opposed to a non-deductible event, a personal item for example, if it's deductible then the measure of the deduction is the amount included in gross income and if there was any question in case law prior to the enactment of 1341, that question now must be taken to the --
Justice Abe Fortas: Well, I understand your position.
I haven't started with.
What do you do about subparagraph 2 specifically?
Supposing that my colloquy with the Solicitor General.
Mr. Robert J. Casey: Yes, subparagraph 2 to us makes it plain that if the -- if there is an allowable deduction, I don't care as the Solicitor General said, we've had some exchanges as to whether the deduction in the current year is ordinary and necessary business expense under 162 or a loss under 165, we don't care.
If it's deductible because it is determined that part of that amount included in gross income must be restored because it turned out that the taxpayer did not have the unrestricted right thereto, that the measure of the deduction is in 1341 (a) (1) and (a) (2) taken together, that there's no room for argument anymore that the inclusion in gross income must have been of some revenue-producing benefit to the Government.
Now, the difficulty inherent in this case is the confusion of the percentage depletion deduction in the prior year with the ordinary and necessary business expense for loss whichever in the year 1958 which is before this Court.
If you follow the government's reasoning, you would -- you are led to the conclusion that when you have -- when the taxpayer in the years of the receipt of the income, severed and sold $505,000.00 worth of gas that it suffered two depletions.
One, the depletion of a property.
But then also some other depletion amount which are taxed to $505,000.00 and serve to reduce the tax impact of those dollars when paid out in the subsequent year in a deductible amount.
There's no authority for that.
There's no way it seems to us that its results can be accommodated.
Justice Byron R. White: Do you have an election in the oil business as to how to take the depletion?
Mr. Robert J. Casey: Yes sir, you take a cost depletion or percentage depletion.
Justice Byron R. White: (Inaudible)
Mr. Robert J. Casey: Yes sir.
And I must say that the election of the percentage depletion of course results in the tax benefits of the taxpayer.
But there's no way it seems to us that the payment of money which is what happened to the taxpayer here can give rise to a reduction in any basis.
There's no way we can add to the basis of our properties because we didn't acquire them.
We never got the mineral back.
We're not talking about the double deduction of the Ludey or Ilfeld cases here.
They're separate complete unrelated deductions.
Settlement of a lawsuit and the payment of the dollars involved in that had no more to do with the prior year's production except as the basis of the claim against this than the payment of compensation or interest in the later year.
We also find it difficult to accommodate the line of cases which the Government decided in which the thrust is that previously deducted items become income in the year of recapture or restoration.
We would point out to you that in the year 1958, the taxpayer never recovered anything.
The mineral which it produced was long gone.
It's the impact of the settlement of a lawsuit on its operations for that year was entirely disadvantageous.
There was no recovery, there was no restoration and those cases are therefore we submit inapplicable here.
It seems to us that the percentage depletion allowance, because of its peculiar impact on the taxpayer, because it doesn't relate to cost or discovery value or any other stated amount gives rise to conditions which are probably not reconcilable with established doctrine in other areas with Ludey.
It had a cost basis for this property and will recover that cost through cost depletion and depreciation or with Ilfeld who had a cost basis in the stock for its subsidiary companies and effectively recovered that basis through the absorption of the subsidiaries' losses against its income.
That is the thrust of our argument.
If Congress had intended the result contended for by the taxpayer -- by the Government here, it would have been simply done.
I referred earlier to the Court of Claims case decided in 1953 which showed how simply it could be done, United States against Perry.
In that case, the taxpayer donated property to a charity, deducted the amount on its return in the year of the donation and recovered the property in a later year to a tax detriment.
The Court of Claims sought the fair way to do it would be to look back and see what tax advantage did he get from the donation in the year he made the donation and said that that should be the measure of his tax detriment in the year of recovery but the very Government that is here urging that approach to the Skelly case prevailed upon the Court of Claims to overrule the Perry decision.
Pointing out that the annual accounting concept so ingrained in the tax law by the decisions of this Court made that result impossible under the law and on the urging of the Government, the Court of Claims recognized this error, went to the annual accounting concept even though the taxpayer in the Alice Phelan Sullivan case suffered tax-wise drastically.
It's a two-way street.
There's going to be tax equalization, it's got to be equalization for the Government and for the taxpayer.
Under the law as enacted by Congress, there cannot be tax equalization.
The arguments advanced to this Court to overrule the decision below are more properly advanced we submit to the Congress.