UNITED STATES v. FOSTER LUMBER CO.

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Argument of Stuart A. Smith

Chief Justice Warren E. Burger: We will hear arguments first this morning in number 74-799, United States against Foster Lumber Company.

Mr.Smith you may proceed whenever you are ready.

Mr. Stuart A. Smith: Mr. Chief Justice and may it please the Court.

This is a Federal Income Tax case here on certiorari to the United States Court of Appeals for the Eight Circuit.

It involves an application of Section 172 of the Internal Revenue Code of 1954, which permits carry back and carryover of net operating loss deductions.

The question presented in this case is whether the respondent can carry back a $42,000.00 net operating loss incurred in 1968, as an offset against its 1966 taxable income of $174,000.00, and after that offset, used $35,000.00 of that loss a second time against its 1967 taxable income.

From a mathematical and statutory standpoint, we submit the answer to this question is plainly, no.

The $42 --

Justice Harry A. Blackmun: When you used the term a second time it has to be, no, does it not?

Mr. Stuart A. Smith: Exactly, but we think --

Justice Harry A. Blackmun: Your opposition will disagree with that?

Mr. Stuart A. Smith: I am confident they will, Mr. Justice Blackmun.

Justice Potter Stewart: You stated the issue in a loaded way --

Mr. Stuart A. Smith: Yes, but we think it is a way which is supported by the statute.

Justice Potter Stewart: Yes, I know you are.

Justice Lewis F. Powell: They used the first time did not benefit the taxpayer at all, did it?

Mr. Stuart A. Smith: Did not benefit the taxpayer in the sense it did not reduce --

Justice Lewis F. Powell: It did not get any tax benefit whatever?

Mr. Stuart A. Smith: It did not reduce its tax liability.

Justice Lewis F. Powell: So when you say it was used, you are saying it just disappeared --

Mr. Stuart A. Smith: It disappeared by operation of the statute --

Justice Lewis F. Powell: Right.

Mr. Stuart A. Smith: -- Mr. Justice Powell.

We submit that no part of the $42,000.00 loss remains for offset against 1967 income, the facts are stipulated and relatively straightforward.

In 1966, the taxpayer corporation had taxable income of a $174,000.00.

In 1968, it incurred a net operating loss of $42,000.00.

In accordance with Section 172 of the Code, the respondent carried back its loss, $42,000.00 loss to 1966.

Once that loss arrived back in 1966, the respondent had to re-compute its tax liability for its earlier year in 1966 as if that loss occurred in 1966.

Now, it had to re-compute its tax liability pursuant to the code under two different methods.

One is the so-called “regular method.”

Section 11 provides for taxation of corporate income in accordance with prescribed rates.

Now, once having subtracted $42,000.00 from $174,000.00, it arrived at the recomputed taxable income of $132,000.00.

If the tax on that, on the regular -- according to the regular method was $58,000.00.

It then engaged in an alternative tax computation, which was provided for corporations pursuant to Section 1201 (a) of the code.

That alternative computation, it is permitted for corporations, which have net long -- net long-term capital gain.

Now, its computation is set forth in our brief at, the various computations at page four, the Court will see that under the alternative method, the respondent subtracted its $42,000.00 loss from its $174,000.00 of taxable income and again had recomputed taxable income of approximately $132,000.00.

It then had engaged in the two-step computation pursuant to the alternative tax.

It subtracted its capital gain, well, essentially for short-term -- for shorthand purposes we call, its long-term capital gains, its partial tax-base was zero or negative amount and then it added it to that a flat 25% tax on its capital gains, the tax under that method, “alternative method,” was $41,000.00.

Now, pursuant to the code, the taxpayer, the prescribed tax is the lower amount that is applicable.

Now, this suit involves the year 1967.

All the computations I have described thus far were applicable to year 1966.

The respondent filed a refund claim for that year and that is the year it sued, asserting that even though its $42,000.00 loss, it was 1968, had been subtracted from its taxable income of $174,000.00 to yield a recomputed taxable income figure of a $132,000.00, it claimed that $35,000.00 of that loss was still available to offset its taxable income in 1967 which amounted to about $229,000.00.

Now, the District Court upheld the respondent’s claim and the Court of Appeals affirmed.

In so holding however, the Eight Circuit acknowledged that its decision was contrary to the applicable Treasury Regulations, which were adopted shortly after the 1954 codification.

Justice Harry A. Blackmun: In this connection, has the Government’s position on this issue always been what it is today?

Mr. Stuart A. Smith: I think so Mr. Justice Blackmun.

It is my impression that the Government’s position has uniformly been in accordance with the position we urge here and I might add also that the commentaries shortly after the 1954 coder in the late 50s and early 60s prior to the Tax Court’s Chartier decision, were uniformly in support of the Government’s reading of the statutes.

Now, at the time of the Eight Circuit’s decision in this case, there were two circuits, which had rejected our position.

However, they were briefed per curiam affirmances.

In fact, the First Circuit in dismissing the Government’s appeal, I mean, affirming and dismissing the Government’s position, just characterized the position as unimportant and seldom occurring.

The Eight Circuit here frankly acknowledged that it was influenced by the cumulative weight of these two adverse Circuit decisions.

Justice Potter Stewart: They were what, affirmances of the Tax Court?

Mr. Stuart A. Smith: One was an affirmance of the Tax Court in the Chartier case --

Justice Potter Stewart: In the Chartier case?

Mr. Stuart A. Smith: And the other one was in affirmance of a District Court, California decision, the Olympic Foundry case.

Justice Potter Stewart: Which came after the Chartier case?

Mr. Stuart A. Smith: Which came after the Chartier decision.

Justice Potter Stewart: And in which the United States District Court relied upon --

Mr. Stuart A. Smith: In which the United States District Court relied upon the Tax Court and was affirmed per curiam by Ninth Circuit.

Now, shortly after within about three months of this decision, the Fourth Circuit issued what we believe is a well considered and comprehensive opinion in the Mutual Assurance Society of Virginia Corporation case, in which the Government’s position was squarely upheld as conforming with the statutory definition of taxable income.

Shortly after that, the Sixth Circuit in the Axelrod case rejected an individual taxpayer's similar attempt to cumulate and pyramid the benefits of both the net operating loss carried back provisions and the alternative tax computations.

We submit a resolution of this issue depends upon a careful analysis of the applicable statute, which is Section 172 of the 1954 code, specifically Subsection (b) (2).

The pertinent part of that statute is set forth in our brief at the top of page 18.

It provides, “the portion of such loss, which shall be carried to each of the other taxable years, shall be the excess if any of the amount of such loss, over the sum of the taxable income for each of the prior years to which such loss may be carried.”

Now, the term “taxable income” in the statute is important.

That is a technical term, which is elsewhere defined in the code in Section 63 (a), and taxable income in accordance with this definition means gross income minus the deductions allowed by this chapter.

Now, here the 19 -- taxpayer’s 1966 taxable income was indisputably a $174,000.00.

Its 1968 loss $68,000.00 -- it was $42,000.00. Carrying back the $42,000.00 loss to the $174,000.00 of taxable income, as the statute prescribes, in our view demonstrates that there was no statutory excess of a loss over taxable income, which the taxpayer could then use for a succeeding year.

Now, the Eight Circuit in this case, in grappling with this admittedly technical problem, said it is impossible to find any plain meaning in the statutory language that would dispose of this controversy.

The Court then engage in what we think is an erroneous groping for policy considerations.

We think the statutory language is absolutely plain and admits of no other rational interpretation.

The statute prescribes that the loss be netted against taxable income.

Here the taxable income was $174,000.00, the loss was $42,000.00, there is no excess to carry forward to the year 1967.

Justice Lewis F. Powell: Mr. Smith, you are saying as I understand it, that the majority of the Tax Court was irrational in interpreting language that at least to me it seems ambiguous?

Mr. Stuart A. Smith: Well, we do not think it is ambiguous Mr. Justice Powell, and I would like to --

Justice Lewis F. Powell: The Tax Court at least --

Mr. Stuart A. Smith: Well I, well I--

Justice Lewis F. Powell: At least presumptively its rational on tax matters, have arrived --

Mr. Stuart A. Smith: I think, I think that is correct and I have as much deference for the Tax Court as perhaps anyone, but I think in this instance they misconstrued what we think is plain statutory language, which demonstrates that our interpretation is the correct interpretation.

Chief Justice Warren E. Burger: Do you think the Eight Circuit was wrong then in looking the underlying purpose of statute?

Mr. Stuart A. Smith: No, I do not think the Eight Circuit is -- was wrong, but I think in looking to the purpose of the statute in any statutory interpretation case, I think the Courts necessarily must look for policy, but I think they were wrong in their initial premise, that the statutory language had no plain meaning and that it was necessary then to look to some external purpose.

These are detailed statutes Mr. Chief Justice, and I think that they had been amended constantly since 1921 and it is very difficult to discern any particular policy, because at any given time technical amendments are introduced which alter what one might perceive to be a basic policy.

To us -- to the extent that there is a statutory historical evidence of how this decision should come out, it seems to us that Section 122 (b) of the 1930 Code -- 1939 code is instructive in the sense that I think it is without beyond doubt as we have point out in our reply brief, that the taxpayer’s position is impossible under the 1939 Code because the phrase upon which they rely, the final phase of the statute “to which such loss may be carried” did not exist in the 1939 Code.

And when Congress amended the net operating loss carried back and carryover provisions in 1954, there is no indication that 172 (b) (2) was meant to do anything different than it had done under the 1939 Code.

There were number of changes and the committee reports discuss them at great length, the span of years was enlarged and a variety of things were accomplished, but this basic proposition that in determining how much of a loss is “available” after it proceeds back was always to be a netting of loss against taxable income, which in this case includes all income, both ordinary income, what on my quote ordinary income and capital gains and in this case, that amount is a $174,000.00 and the $42,000.00 loss simply does not survive past that computation.

Justice Byron R. White: Well does the -- does the loss -- is a loss available to taxpayer in ’66 at all?

Mr. Stuart A. Smith: Is the loss available to the taxpayer in ’66?

Justice Byron R. White: I know you apply it to his income, and your, the income is more so the loss is all used, but how about in figuring his alternative tax?

Mr. Stuart A. Smith: Well, in figuring his alternative tax as the --

Justice Byron R. White: Do you still use the same amount of capital gain as you -- as he does?

Mr. Stuart A. Smith: Of course, if you -- I think if you look at the computation at page 4 you will -- $42,000.00 is offset against the $174,000.00 of taxable income, that yields taxable income of under, pursuant to Section 63 (a), of approximately $132,000.00.

Now, I think the quarrel between the parties is to the effect that it -- it contends that --

Justice Byron R. White: I understand what the quarrel is.

I just want to know from you just from my own information whether or not the alternative tax is figured on the full amount of the capital gain?

Mr. Stuart A. Smith: The alternative tax is figured on the full amount --

Justice Byron R. White: $166,000.00.

Mr. Stuart A. Smith: $166,000.00 and that is, 25% of that yields to the tax figure for that year.

Justice Byron R. White: Now, but a $166,000.00 or the $173,000.00 is capital gain.

Mr. Stuart A. Smith: That is right.

Justice Byron R. White: And you will apply the $42,000.00 to reduce the total taxable income to $131,000.00?

Mr. Stuart A. Smith: That is right.

Justice Byron R. White: Now, I suppose it would be possible to say that the $34,000.00 ought to reduce the amount of capital gain?

Mr. Stuart A. Smith: It would be possible to say that as an abstract matter, but it has been settled that that is not to be the case.

Justice Byron R. White: Well, then it certainly is true then that the taxpayer gets no benefit whatsoever from the --

Mr. Stuart A. Smith: He gets no reduction in its tax liability, although --

Justice Byron R. White: Although it reduced the amount of capital gain, he would get some benefit?

Mr. Stuart A. Smith: Yes but the Weil case has disposed to that proposition and that -- and that the correctness of the Weil issue is not at issue in this case.

The tax in fact, the very Tax Court --

Justice Byron R. White: You may say it is not at issue, but it is an important matter in --

Mr. Stuart A. Smith: Well, I do not think it is -- it is even strictly at issue Mr. Justice White, because for purposes of, if the Court were to agree with our -- with our computation --

Justice Byron R. White: (Voice overlap) you are saying, we must decide the case on the assumption that the taxpayer gets no benefit whatsoever from $34,000.00 of his loss?

Mr. Stuart A. Smith: Gets no reduction in tax liability, that is right and essentially that is --

Justice Byron R. White: That is all I wanted to know.

Mr. Stuart A. Smith: Okay.

Justice Potter Stewart: But he would even if following your theory he would have if the figures were different?

Mr. Stuart A. Smith: He might if the figures were different --

Justice Potter Stewart: I mean another taxpayer might --

Mr. Stuart A. Smith: Another taxpayer --

Justice Potter Stewart: It is not inevitable that a taxpayer never would, that is my --

Mr. Stuart A. Smith: Exactly.

This one did not simply because, if you look at 1967, the table at page three of our brief you will see that there is a large amount of ordinary income and a large amount of capital gain, so there would not be any benefit.

Even under a contra-Weil approach, although we do submit -- so we do submit strictly speaking that since the year 1967 it is at issue here for this taxpayer, the correctness of Weil is not really an issue in this case, although we submit that it is correct.

Justice Byron R. White: (Inaudible) he does not get any benefit from this $34,000.00, you say, he gets no tax benefit --

Justice Lewis F. Powell: Mr. Smith.

Mr. Stuart A. Smith: Yes.

Justice Lewis F. Powell: Approaching Mr. Justice White's point from a different angle, if you view this result in terms of economic reality, the way it works out with me is that this taxpayer net economic gain over the three-year period was $361,000.00, what the Government is proposing to do is to tax $396,000.00.

Mr. Stuart A. Smith: I do not think that is true, Mr. Justice Powell.

Justice Lewis F. Powell: Well, that is the reverse of the coin you have just conceded and that is that you are not giving the taxpayer a credit for $35,000.00 of loss, in effect you are taxing him?

Mr. Stuart A. Smith: Well, the reason we are not giving him credit so to speak, that simply by operation of the alternative tax computation.

Justice Lewis F. Powell: Right.

Mr. Stuart A. Smith: Exactly.

Now, for the taxpayer to prevail we submit, you would have to in effect merge these two statues 1201 (a) and 172, and we submit they are simply not to be merged.

Now --

Justice Lewis F. Powell: Statutes that you are talking about involve two basic tax approaches.

Capital gains are quite different from ordinary income.

Capital gains are often, perhaps usually, the product of accretion over periods of years, and if capital formation in this country is to be encouraged, and that was the purpose of the 25% alternative tax, it seems to me that the position you are arguing is counter productive to the basic theory of a capital gains tax?

Mr. Stuart A. Smith: Well, that may be true as a legislative matter, but we submit that when Congress used the term “taxable income” in Section 172 (b) (2), it very specifically rejected the notion of segmentation of these two kinds of -- of taxable income into its component parts which the alternative tax computation takes into account.

When this $42,000.00 loss is carried back, what the taxpayer essentially is doing, is introducing the mechanics of the alternative tax computation with its segmented approach, that is its partial tax-base plus the alternative tax, plus the 25% flat tax computation, into the interest deices of Section 172 (b) (2).

And we think that without some indication from Congress, because the statute is replete with modifications to the basic -- to the basic concept of taxable income, and there is no modification which would admit the segmented computation that the taxpayer seeks to introduce.

There are only two statutorily prescribed computations; one, the regular tax computation and two, the alternative tax computation.

What the taxpayer is trying to do is to take its $42,000.00 loss and net it against a segmented part of its 1966 taxable income, and without any statutory warrant for that position, we submit that it is simply not acceptable without some indication by Congress that this was to be the result.

Now, we think that the statute does pose an insurmountable obstacle to the taxpayer’s position, and as a result it has to construe the statute in accordance what we believe is a forced and no natural reading.

Now, looking back at page 18 again of our brief, it argues that the phrase, “to which such loss shall be -- to which such loss may be carried,” modifies the phrase taxable income as well.

Now, that was essentially the gist of the Tax Court’s holding in Chartier Real Estate Company.

And we submit there is no statutory basis for saying that the loss of $42,000.00 is carried back against only the $7,000.00, which represents the partial tax-base under Section 1201 (a).

There is no support in the legislative history to that approach and moreover the term, “carry” contrary to the taxpayer’s argument and the taxpayer -- and the Tax Court’s position has a temporal connotation and not insofar a loss is carried back from 19 -- from one year to another, from 1968 to 1966.

And there is no basis for saying that the loss is carried back to a particular type of income in 1966, it is carried back to the --

Justice Byron R. White: Did the taxpayer had $15,000.00 for the capital gain in ’66, and the same loss to be carried back?

I suppose the loss carried back to reduce taxable income would have eaten up all that income, it would have eaten up all of the loss, I mean, it would eat up all of the income?

Mr. Stuart A. Smith: Well, you say that we have a $42--

Justice Byron R. White: Including there would been no alternative tax --

Mr. Stuart A. Smith: There have been no alternative tax and the loss would have eaten up all of the income.

We submit that essentially the alternative tax is a separate statutory system, designed by Congress to benefit the taxation of capital gains and it cannot be -- its mechanics cannot be imported into this --

Justice Byron R. White: So in my example there would have been -- the taxpayer could not have just carried forward that part of the -- carried forward the part of the loss carry back that was not eaten up by ordinary income?

Mr. Stuart A. Smith: In your example with no capital gains, the regular tax computation would have been used and whatever the -- if -- then it would have been forty-two less fifteen and there would have been a remaining loss available.

Justice Byron R. White: Yes.

Mr. Stuart A. Smith: But essentially the --

Justice Byron R. White: But if there had been ordinary income of five and capital gain of fifteen, the carry back would have been reduced by twenty?

Mr. Stuart A. Smith: Exactly.

Justice Byron R. White: And not just by five?

Mr. Stuart A. Smith: Exactly.

Justice Byron R. White: Which is the claim in this case?

Mr. Stuart A. Smith: Exactly, exactly.

If there are no further questions, I would like to save my remaining time for rebuttal.

Chief Justice Warren E. Burger: Very well.

Mr. Baker.

Argument of Russell W. Baker

Mr. Russell W. Baker: Mr. Chief Justice may it please the Court.

The Court by its questions has indicated that it understands the Government’s real position in terms of the consequences of its position, and that is to repeat, that under the special circumstances of this case, the net operating loss of the taxpayer is to be wasted.

Put in numbers, this means that that part of the capital gain we received in 1966, which absorbed the loss, is really taxed at a 73% rate in this manner.

25% for an alternative tax, 48% by reason of the failure to allow us to carry it against ordinary income of another year, disregarding surtax exemptions.

And today with the alternative tax rate on corporation at 30%, instead of the 25% which existed in the late 60s, that rate -- that total effective rate would be 78%.

Chief Justice Warren E. Burger: Well, I gathered what Mr. Smith was saying is that when the statute is clear, that is bound have some situations that are going to cut both ways, sometimes the statute will be good for taxpayer and sometimes it will work the other way and yet, if the statute in its language is clear, we are obliged to ignore the policy and the objective?

Mr. Russell W. Baker: I believe that would be correct, Your Honor.

If the language is clear you are obliged to ignore the policy.

Chief Justice Warren E. Burger: Where do you think the language is not clear in --

Mr. Russell W. Baker: First of all and primarily, we rely upon the same analysis used by the Tax Court, and that is the sentence in question is capable of being read that to which the loss may be carried, modifies taxable income.

Here is where the Eight Circuit below agreed with the Tax Court.

It said either reading of the -- of this sentence is plausible, to use its exact words, this phrase could modify taxable income or it could modify the years, the earlier taxable years.

And if there were no doubt about this, if -- then we would have to fall back on alternative arguments.

If the Court found that the modified phrase did not modify taxable income at all, we would have had alternative arguments, but we chose to place our argument on the ground used by the Tax Court that there was an ambiguity.

The Tax Court --

Justice Harry A. Blackmun: The Tax Court has been consistent through the years on this, has it not?

Mr. Russell W. Baker: Yes, Mr. Justice Blackmun, the Tax Court first ruled in 1969, since then it has a couple of more cases, involving the same question, and as late as last year it said, “we remain convinced of the soundness of the Chartier decision.”

That decision did take on, unlike almost any other case we have, did take on both prongs of this problem.

The taxpayer is first asked to carry back his loss and take it against the capital gain, thus raising problem, which was raised by Mr. Justice White.

Could he take it against the capital gain?

The Tax Court examined the alternative tax provisions very clearly and said it is unmistakable, you cannot do it, Congress has just said so.

So no, the answer is no, you cannot take it there.

The taxpayer’s alternative was I should like to carry the loss over to the next year since I could not use it in the capital gain here.

The Tax Court here turned to the loss provisions of the code and found under the sentence that we were discussing, that he could carry the loss on to the next year.

So the Tax Court had both -- both things before it.

It upheld its wild option that it cannot reduce the capital gain, but it allowed the carry over to the next year and did not therefore require the taxpayer to waste his net operating loss.

Now, the unusual feature of the Government’s position in this case is that the Government will readily concede to this Court, that a capital gain in some of the eight possible carry years will not affect the matter at all.

In a few cases like ours, where the capital gain comes early in the carry period, then we are required under the Government’s position to waste our loss, but if the capital gain is delayed far enough in this total eight-year period, so that ordinary income can accumulate to absorb the loss, then the taxpayer gets both, the use of his loss and the favorable capital gains rate.

So, it is a matter of timing within the carry period.

This matter of, and when I say a matter of timing, I am talking about timing within the eight possible carry years.

The discrimination between taxpayers within that period under the Government’s position is based on no policy whatever.

It is wholly fortuitous, the order in which --

Justice Potter Stewart: There is nothing new about the proposition that the internal revenue code has all sorts of classification as it resulted in any individual case in fortuitous of impact?

The very fact that you are limited for example in your carry over -- carry year, three years back and five years forward, leads to fortuitous results for taxpayers who either have, again whether if their timing is wrong?

Mr. Russell W. Baker: I agree with your comment entirely --

Justice Potter Stewart: If the carry years do not cover their loss, for example --

Mr. Russell W. Baker: I agree with your comment entirely.

Justice Potter Stewart: It is fairly fortuitous as to the arbitrary three-year back and five-year forward results and sometime an fortuitous impact?

Mr. Russell W. Baker: Certainly, it is.

I do not claim that if it is the job of this Court to straighten out all of the angles in the Internal Revenue Code.

As you say, we cannot carry a loss back more than three-years, or we cannot carry it over more than five-years.

The reason we have stressed this, as the Courts below did is, if the Court finds there is an ambiguity in this language and it is not quite clear what Congress was doing, then it is in order for the Court to look to the consequences in order to select between competing interpretations.

Foster, to continue this line of thought for one moment more, Foster must in this ambiguous area waste its net operating loss.

But if it has a competitor across the street, identical in every respect to it, except one and that is that its capital loss came one year later, two years before the net operating loss, that competitor gets the capital gain rate, gets to use its net operating loss, but under the Government’s position we do not.

Again, Mr. Justice Stewart, if this is commanded by Congress, we have to live with it.

We have tried to assist the Court on this very point by including in our brief at page 25, a table which shows the consequences of the Government’s position.

Now, this is not a table with assumed specific dollars in it.

It is just a plain statement of what happens to a net operating loss when it encounters a capital gain in each of the eight carry years.

And it states the government what happens under the government’s position and what happens under our position, and therefore, we hope effectively, points up the point we are trying to make in this regard.

We should say something because this is our opportunity to reply to the Government’s reply brief.

Mr. Justice Powell mentioned a moment ago that the -- that the amount the Government proposes to tax us on in the period is $396,000.00, instead of the $361,000.00.

The Government strenuously contests this point in its reply brief.

At page eight, they say and I read from the Government’s reply brief at page eight, “respondent and the amicus further argue that the Government’s position with tax respondent on a total of $396,000.00 for the three-year period ’66–’68, although respondent’s aggregate income for the period was $361,000.00.”

A careful analysis of the figures demonstrates that this statement is simply inaccurate.

Our response is our statement is accurate.

The Government’s error is plain in this regard and as pointed up by the statement on the next page, page nine, where the statement is made computing the tax, and it is underlined, on the same $132,000.00 of taxable income, but by the alternative method provided in Section 1201, produce the lower tax of $41,000.00.

As in the exchange with Mr. Justice White, I think it was brought out clearly to the Court that the alternative tax was on the total $167,000.00 of capital gain.

The Government in its point one and its reply brief says the statute is clear.

Of course, if the statute is clear and the Congress commands us to do as the Government indicates, we lose.

We have felt that our ambiguity in the statute is demonstrated by the opinions of the lower court and that the consequences we have pointed out are important and should be considered by this Court.

The fact is that the Government is asking for such an unusual out of the ordinary result here that it had seemed to us that they should be able to point to some indication by Congress, that it knew, it was enacting the result, which they have asked for.

The fact is that over the years, neither Congress has indicated that nor more importantly has the Internal Revenue Service indicated to Congress that it was taking an administrative position that would yield such a result as they ask for today.

And this problem has been with us for a long enough time for a some kind of administrative position to have been communicated to Congress on this point, yet I think there is none.

The Government in its reply brief and also this morning states, the taxpayer result would have been impossible under the 39 code.

We do not agree.

We think our result could have been possible under the 39 code for a couple of reasons if not more.

Certainly the same policy factors were acting under the 39 code as are acting today.

The Merrill case cited by the North River amicus brief, is a clear indication that the Courts could have easily reached our result under the 39 code.

Second thing I would like to point out is the existence of the Treasury Regulation under the 39 code, which says, net operating loss is available except to the extent absorbed by the taxable income of earlier years.

Now, the word “absorbed” surely has some overtone of usefully applied.

Congress would have been looking at that Regulation, we may assume, when it enacted the 1954 Internal Revenue Code, at which time, as the Government’s counsel has pointed out, this whole section was rewritten, lots more was done to it than merely add the phrase “to which the loss may be carried,” which has so emphasized.

It would be entirely within the realm of possibility for that phrase to have been added as a matter of clarification.

Congress could have well felt or whatever draftsman was acting for Congress could have well felt, that he was simply continuing a computational rule which had there to fore existed.

Mr. Chief Justice, the respondent would ask this Court to affirm the judgment below and in effect the views of the Tax Court for the reasons that are presented in our brief and here this morning.

Chief Justice Warren E. Burger: Thank you.

Mr. Smith do you have anything further?

Rebuttal of Stuart A. Smith

Mr. Stuart A. Smith: If the Court has no further questions we submit.

Chief Justice Warren E. Burger: Very well gentleman, thank you.

The case is submitted.

Print this transcript Transcript: 

Argument of Stuart A. Smith

Chief Justice Warren E. Burger: We will here arguments next in 74-799, United States against Foster Lumber.

Mr. Smith, I think you may proceed.

Mr. Stuart A. Smith: Mr. Chief Justice, and may it please the Court.

This is a federal income tax case which comes here on a writ of certiorari to the United States Court of Appeals for the Eighth Circuit.

It involves Section 172 of the Internal Revenue Code of 1954, which permits carrybacks and carryovers of net operating loss deductions.

The question presented is whether respondent, a corporation can carryback a $42,000 loss it incurred in 1968 as an offset against its 1966 taxable income of $174,000 and thereby reduce its taxable income to $132,000 and after that offset, take $35,000 of that $42,000 loss and use it as an offset against its 1967 taxable income?

We submit that from a mathematical and statutory standpoint the answer to this question is plainly no.

$42,000 can only be used once to offset the $174,000 of taxable income and no part remains for further use as an offset for 1967.

The facts are fairly straightforward and were stipulated to the District Court and can be summarized as follows:

In 1966, respondent had taxable income of $174,000.

In 1968, it had a loss, ended operating loss of $42,000.

Now, pursuant to Section 172, respondent carried back its $42,000 loss to the third year that is 1966, and then proceeded to compute its 1966 tax liability as if that $42,000 loss was incurred in that earlier year.

Now, the Code for corporations prescribes two methods of taxation: One the so-called regular method under Section 11 of the Code, provides for regular corporate income tax rates, and in this case that regular method yielded a tax liability of $58,000, those are the corporate rates on a $132,000 of taxable income, which was $174,000 minus $42,000.

Now, under Section 1201(a) of the Code, respondent was required to compute its tax under the alternative tax computation, which corporations can avail themselves off when they have capital gains.

It engaged in the prescribed computation, which we have set forth in our brief at page 4 under the alternative method.

Basically it is a two-step approach.

It took its $173,000 or what we say was $174,000 essentially, subtracted the $42,000 loss, got taxable income of $132,000 and then what it had to do was to subtract out its capital gains, and basically the step-one operation to tax yielded zero or a negative number.

It then had to compute the capital gain segment, the step-two part of the partial tax, the capital gains tax, which is a flat 25% of the $166,000 of what the statute refers to as long-term capital gain over short-term capital loss, but for these purposes, we simply call capital gains, and it got a tax liability of $41,000.

Now under the Code, respondent was required to report its tax liability under the net effect yielded to the lower liability, so it did and it paid taxes of $41,000 for 1966.

Now, this suit involves the year 1967.

Respondent filed a refund claim and asserted that even though its $42,000 loss had been used to offset its taxable income in its entirety, that somehow it still has $35,000 of this loss available to offset income in 1967.

Respondent’s claim essentially is that a segmented approach is the proper approach and that is that the $42,000 1968 loss should only be offset against its $7,000 of ordinary income and that yielded $35,000 for use in the subsequent year.

The District Court in Missouri upheld respondent’s claim and the Court of Appeals for the Eighth Circuit affirmed.

In so holding, I think it is significant that the Eighth Circuit acknowledged that its holding was contrary to the Treasury Regulations which have, which were promulgated shortly after the 1954 codification and have existed more or less in the same state ever since.

Justice Harry A. Blackmun: On the other hand the Eighth Circuit had a consistent holding on the Tax Court in elsewhere?

Mr. Stuart A. Smith: That is true Mr. Justice Blackmun.

I was just getting to that.

Justice Harry A. Blackmun: Perhaps that is a little more persuasive than Treasury Regulations.

Mr. Stuart A. Smith: Well, we think that Treasury Regulations are correct and we think the Tax Court in this case is incorrect as I will attempt to demonstrate.

At the time of the Eight Circuit’s decision, the First Circuit and the Ninth Circuit had indeed rejected the government’s position, but all be it in brief Per curiam affirmances.

In fact, the First Circuit characterized this question as unimportant and seldom occurring even though I think that subsequent developments have indicated that the issue is important and frequently occurring.

In our petition for Certiorari, we told the Court that there are about $34 million of taxes riding on this issue and that it frequently occurs because of the operation of the alternative tax and the net operating loss carryback.

I think it is fair to characterize the Court of Appeals’ decision as influenced largely by the cumulative weight of two appellate decisions rejecting the Government’s position.

But thereafter, and in fact, within three or four months after the decision in this case, the Fourth Circuit rendered its decision in Mutual Assurance Society versus Commissioner, which we submit to the Court as a well reasoned and proper analysis of the statutory problem here and thereafter the Sixth Circuit in Axelrod versus Commissioner upheld the Commissioner’s position in a case involving an individual taxpayer, but its opinion largely criticizes the Tax Court’s decision in Chartier Real Estate Co. and speaks approvingly of the Fourth Circuit’s decision in Mutual Assurance Co.

Now, the resolution of this problem depends upon a careful analysis of the applicable statutory provision which in this case is Section 172(b)(2) of the Internal Revenue Code.

Now, we have set out the pertinent part of this provision at top of page 18 of our brief.

The statute reads the portion of such loss which shall be carried to each of the other taxable years shall be the access if any of the amount of such loss over the sum of the taxable income for each of the prior taxable years to which such loss may be carried.

Justice Potter Stewart: Is it not the key phrase in your submission at least, taxable income, and technical meaning of that?

Mr. Stuart A. Smith: Indeed, Mr. Justice Stewart.

We submit that taxable income is a statutory term of art and that it is defined in Section 63 of the Code which we have set forth at page 36 in our Appendix through our brief on the merits which again says that taxable income is gross income minus the deductions allowed by this chapter.

Now in 1966, the respondent’s taxable income was $174,000.

Carrying back that loss and determining the excess if any of the amount of such loss over the sum of the taxable income for 1966, demonstrates in our view that that loss is completely absorbed and that there is no longer any part of it available for use in a subsequent taxable year.

Now, respondent basically does not dispute the definition of taxable income which is set forth very plainly in the Code, but it submits that because it used the alternative tax computation in the early year, that somehow that requires a different result in this case.

Now, we submit that the statutory language is plain and that disoperation of subtracting $42,000 from $174,000 in yielding a $132,000 of taxable income is dictated by the statute and that there is no basis for inferring any further modifications from the statutory term, 'taxable income'.

Indeed, if the Court would examine Section 172(d) of the Code, you will find that there are basically a group of modifications that Congress has prescribed from the term 'taxable income', but the modification that respondent seeks to engraft on the Code is not here.

These are detailed statutes and we think in the first instance that the language has to be employed pretty much in a mechanical sort of way because these are detailed and mechanical statutes designed to provide limited kinds of relief for averaging, so to speak and alleviating some of the harsh results that might be caused by annual accounting method which is sort of bedrock of our tax system.

Argument of Unidentified Justice

Unidentified Justice: Mr. Smith, I understand your position.

You think the language is perfectly clear, but it is true, is it not that the Tax Court takes a different view as to the meaning of the language, particularly the meaning of taxable income in the context in which it is used.

Rebuttal of Stuart A. Smith

Mr. Stuart A. Smith: That is true.

Rebuttal of Unidentified Justice

Unidentified Justice: So it cannot be all that clear, can it, if the agency…

Rebuttal of Stuart A. Smith

Mr. Stuart A. Smith: Well, as we have argued in our brief, we think and as the Fourth Circuit has set forth at great length in its opinion, we think that the Tax Court’s reading of the statute is somewhat forced and unnatural because it would require the insertion -- if you bear with me, I am looking again at page 24 of our brief which sets forth the statute again -- we say here that the Tax Court’s construction views the statute as if it read the sum of the taxable income to which such loss may be carried for each of the prior years to which such loss may be carried.

Indeed that, the phrase to which such loss may be carried would have to be repeated twice in order to shore up the Tax Court’s construction or as we would submit modification of the statute.

But as the Fourth Circuit pointed out, even if you were to say that loss had to be carried back against taxable income, it still requires some substantial, we think re-writing of the statute.

You would have to say, loss carried back against taxable income which in this case is still the same $174,000, but you would have to further say, but only to the extent that there was no reduction in tax liability and we think the fact that there was a reduction in tax liability here for 1966, this as a function of Congress’ attempt to impose a lesser burden on long-term capital gains and we think this is basically a statutory trade off.

Essentially, you either get the alternative tax benefits or you get the operating loss carried back.

We think that it is improper for the Tax Court to have concluded that these benefits be pyramided, in effect cumulated, if you will.

Rebuttal of Unidentified Justice

Unidentified Justice: But in this case the benefits are highly-pyramided, are they not?

Do you not end up on your formulation, finish taxing of this tax payer on $35,000 it never ends if you aggregate these three years?

Rebuttal of Stuart A. Smith

Mr. Stuart A. Smith: Well, we do not think so because I think that…

Rebuttal of Unidentified Justice

Unidentified Justice: Don’t the, mathematics work out that way precisely?

Rebuttal of Stuart A. Smith

Mr. Stuart A. Smith: Well, I think that there may be confusion over tax base and taxable income to be sure there is a tax computation on a $166,000, but it is at a markedly lesser rate than the corporate rate, it is flat 25%, this is an enormous benefit and this produces a tax liability of $41,000.

Now, otherwise the corporation would have had to pay $58,000 tax.

Now, in this particular case although I think it is coincidental.

I think it is somewhat graphic that the very “lost” benefit that the taxpayer complains of that is the loss of a $35,000 loss, which in effect is worth $17,500 is made up pretty much equally by the difference between $58,000 and $41,000 which is also $17,000.

So the Congress basically said you either do it one way or the other and this is basically a statutory trade off.

We do not think that.

We agree that there is the loss of the benefit of this $35,000 loss.

Rebuttal of Unidentified Justice

Unidentified Justice: But is it not true that that $17,000 is just a pure coincidence?

Rebuttal of Stuart A. Smith

Mr. Stuart A. Smith: I think it is, but I think it is a helpful gauge in this case because essentially corporations generally pay a tax on 50% of their taxable income and in this particular case they are paying a tax on $25,000 of a larger base.

But we think that essentially you cannot sort of cumulate these benefits and we think that the statutory language, the use of the term taxable income, signals Congress’ clear intent to provide this kind of straight mathematical equation.

I think if there is evidence in the legislative history, here I think I commend to the Court the Court of Appeals for the Fourth Circuit’s exploration of the history of the statute, which indicated that this result, the result that the taxpayer seeks in this case, would not have been available under Section 122(d) of the 1939 Code, which did not use the phrase through which the taxable that last phrase, to the prior taxpayers to which such loss may be carried.

It simply talked about over net income of the intervening year and I think that the fact that Congress reenacted the statute without any attempt to buttress without -- it is the committee reports are totally silent.

It said essentially prior law is reaffirmed and prior law under the old statute clearly would have rejected the taxpayer’s petition.

I also think that it is not without coincidence that shortly after the 1954 Code was codified and before the Tax Court decided, it rendered its Chartier decision that the commentary was uniformly to the effect that there could be situations where a loss would be “loss” so to speak.

That essentially you are either going to get the alternative tax computation or you are going to get the net operating loss carried back and then after Chartier came down, I must confess that I have looked into this question and asked the people of Internal Revenue Service, they received a lot of calls from private tax people also expressing surprise about the Chartier decision.

I know that the history of this litigation is somewhat dogged from the Commissioner’s point of view, we have sought to establish a conflict of decisions and we have succeeded, but it basically because we think that this sort of -- there are approach corresponds to legislative history.

The post Chartier commentary is pretty much uniformly in our favor as well and since the following of our briefs a new article has come out more or less to so to speak the balance, a critical, the only critical article we have been able to find in the Tax Lawyer, which is the publication of the ABA section on taxation, but an article in 29 Tax Lawyer in 4, 1975 issue, entitled “Net Operating Losses and Capital Gains, a Deceptive Combination” and that again supports the Commissioner’s view that you cannot cumulate and then support the view of the Fourth Circuit, that you cannot cumulate the benefits of these privileges.

I think it is also useful if I may to sort of try to go, try to explore for a moment the underpinnings of this whole net operating loss deduction and to demonstrate as I think can be done that the Fourth Circuit’s approach here is eminently a sound one.

For example, what the net operating loss carryback deduction is attempting to do is to in effect say, okay, this $42,000 loss occurred in 1968, but we are going to pretend as if it occurred in 1966.

Let us assume that it occurred in 1966.

I think in this case, it is absolutely plain that what would happened would be that the same $41,000 of tax would be paid by the taxpayer and that there would be no net operating loss carryover, there would be no net operating loss for that year.

Rebuttal of Unidentified Justice

Unidentified Justice: Or to put it in a different way, if in 1968, he had the same income picture as he in fact had in 1966, there would have been no excess loss?

Rebuttal of Stuart A. Smith

Mr. Stuart A. Smith: Exactly, exactly and to the extent that…

Rebuttal of Unidentified Justice

Unidentified Justice: That is putting in the same opinion that way…

Rebuttal of Stuart A. Smith

Mr. Stuart A. Smith: To the extent that there have been complaints about timing and that our position more or less exact rebates accidents of timing as Mr. Justice Stewart points out, the taxpayer’s position also turns on the timing of these things.

I think the fact that…

Rebuttal of Unidentified Justice

Unidentified Justice: Are you trying to say that you are glad Mr. Justice Stewart asked that question?

Rebuttal of Stuart A. Smith

Mr. Stuart A. Smith: I always…

Justice Potter Stewart: And ask you this, and I see if you are glad about this one.

Is it correct that if a taxpayer has a lower tax by use of the alternative method that he must use that method?

Mr. Stuart A. Smith: That is correct.

Justice Potter Stewart: He has no option.

Mr. Stuart A. Smith: That is statutorily prescribed.

Rebuttal of Unidentified Justice

Unidentified Justice: I do not know if you are glad or sorry about that question, but I just…

Rebuttal of Stuart A. Smith

Mr. Stuart A. Smith: I think in this sphere, you can neither be glad nor sorry.

There are things that just are and these are legislative pronouncements and we think that the statutory language is such that to demonstrate that this loss is no longer available for use in 1967.

I want to talk a little -- I just want to mention one other point and that is this decision in Weil v. Commissioner which seems to have been of some -- covered it length in the briefs and that is, that the Tax Court held in Weil that when you use the alternative tax computation, you can not take an ordinary loss and net it against your capital gain segment.

Now, while that is an independent sort of rule, we think that its existence and a fact that it is never been questioned, is instructive for the issue here and that is simply fair as a situation, where deductions are lost, so to speak, they cannot be used, but this is simply a fact that Congress is giving with one hand, the benefits of the 25% flat rate and taking something away with the other.

That decision was affirmed by the Sixth Circuit and it has never been questioned since.

We think here the same rationale applies.

Yes, there is a loss of the benefit of the deduction that might otherwise be available, but we do not think that Tax Law concerns itself with what might otherwise be available.

These are the facts.

These are the configurations of income and the statutory network has to be applied in its prescribed manner and we think when it is applied in its prescribed manner, the answer is simply that the Fourth Circuit was right and that the Tax Court in Chartier Real Estate Company was wrong.

I do not have anything further to say unless there are other questions.

Rebuttal of Unidentified Justice

Unidentified Justice: (Inaudible)

Rebuttal of Stuart A. Smith

Mr. Stuart A. Smith: In figuring the alternative tax, the taxable incomes -- yes, yes…

Rebuttal of Unidentified Justice

Unidentified Justice: Anyway you think of it the tax -- it is even though the rate is lower and they are sifting up capital gains and the taxable income against to which the 25% rate is applied is still what exceeds.

Rebuttal of Stuart A. Smith

Mr. Stuart A. Smith: The taxable income is statutory term and taxable income we submit no matter how you view it, how you ever parse it in this case, is $132,000.

That is what the tax base is $166,000, but the taxpayer’s taxable income in this case, no matter what net that has applied is a $132,000.

Rebuttal of Unidentified Justice

Unidentified Justice: So anyway you have figured the tax, the taxable income exceeds the amount of the loss?

Rebuttal of Stuart A. Smith

Mr. Stuart A. Smith: Exactly.

Rebuttal of Unidentified Justice

Unidentified Justice: Carryback.

Rebuttal of Stuart A. Smith

Mr. Stuart A. Smith: Yes.

I have nothing further.

I would like to save the rest of my time for rebuttal.

Rebuttal of Unidentified Justice

Unidentified Justice: Well, suppose Mr. Smith that as far as the Government is concerned the burr under the saddle is Judge Raum’s decision in Chartier.

Rebuttal of Stuart A. Smith

Mr. Stuart A. Smith: That is the burr on the saddle or the only in our view -- it is really the only exposition of the problem rejecting our position and we think that it pretty much rely its stands on two prongs: One is extrapolation of the statute or essentially saying that the loss is carried back to taxable income and that taxable income is only that ordinary income segment.

We think that is wrong as a statutory matter.

And the other thing that Judge Raum relied on is this rationale which was expressed by the court in Libson Shops vresus Koehler.

But as we point out in our Reply Brief, this is not the net operating loss carryback and carryforward provisions are not fluid system to enable the taxpayer to sort of use a loss, to hunt around for a place where it will do some benefit.

In fact, the three years back and five years forward is essentially a statutory system designed to say well at some point we are going to cut if off these benefits and reassert the strictures, however harsh they maybe of the annual accounting system.

We think that to the extent that there is policy here, it has to be a squared with the detailed rules that Congress prescribe and I refer the Court to its three decisions in Woolford Realty Co., Lewyt and Olympic Radio and Rio Motors where the Court more or less said that these things are detailed rules and they have to be prescribed with their detailed verbiage and indeed in Rio Motors their loss carryover was denied basically because of timing and while that may sadden the particular taxpayer -- we think that, that is really a question for Congress to address itself and not for the statute.

Rebuttal of Unidentified Justice

Unidentified Justice: Well, has the service endeavored to get the statute clarified?

Rebuttal of Stuart A. Smith

Mr. Stuart A. Smith: Is the service endeavored to get the statute clarified, not that I am aware of, although the statute has been…

Rebuttal of Unidentified Justice

Unidentified Justice: But it has been seven years since Chartier…

Rebuttal of Stuart A. Smith

Mr. Stuart A. Smith: It has been seven years since Chartier and I would tell the Court that the statute has undergone revisions both in 69 and only yesterday, but there have been revisions of lengthening the carryback year, and again, I think these revisions demonstrate that Congress works on these problems in detail and it has made certain decisions as how to alter these things and it is never suggested that, there has never been any suggestion in the Congress that the Tax Court’s decision in Chartier was a correct exposition of the statute.

Rebuttal of Unidentified Justice

Unidentified Justice: But there has never been a suggestion that was an incorrect one?

Rebuttal of Stuart A. Smith

Mr. Stuart A. Smith: No, Congress has been sound though.

Rebuttal of Unidentified Justice

Unidentified Justice: I do not think that you would be up to that if you really felt stronger about that.

Rebuttal of Stuart A. Smith

Mr. Stuart A. Smith: Well, my principal occupation is litigation, but…

Rebuttal of Unidentified Justice

Unidentified Justice: But that is not the principal occupation of the IRS?

Rebuttal of Stuart A. Smith

Mr. Stuart A. Smith: It not the principal occupation of the Treasury Department and I am not aware of any legislative effort to solve this problem.

This problem unfortunately has to be solved by this Court.

Rebuttal of Unidentified Justice

Unidentified Justice: Temporarily.

Rebuttal of Stuart A. Smith

Mr. Stuart A. Smith: Temporarily, right.

Rebuttal of Unidentified Justice

Unidentified Justice: May I ask you this as a matter of information, have any new briefs been filed in this case since…

Rebuttal of Stuart A. Smith

Mr. Stuart A. Smith: No, in fact the only, the only new piece of information that I have given to the Court today which is not in our brief is that article.

Rebuttal of Unidentified Justice

Unidentified Justice: 29, yeah, thank you.

Chief Justice Warren E. Burger: Mr. Baker.

Argument of Russell W. Baker

Mr. Russell W. Baker: Mr. Chief Justice, and May it please the Court.

The Government’s real position to us is this; that our net operating loss is to be wasted in our circumstances.

It is a different way of putting it than we have been charged with in the argument which was just concluded.

Now, I mean by wasted that it cannot be used to offset income in another year, income which was taxed to 48%.

The Government says and it made a very clear statement of its case that the capital gain in 1966 on which we paid tax is deem to absorb our loss, leaving it unavailable for use in the following year.

The consequences that our net part of the capital gain which absorbed loss, we pay effectively 73% in taxes.

A 25% capital gains tax and 48% by not being able to use the loss in the following year.

Now, today in 1976, were the problem to arise, the alternative tax now being 30%, the compounded effect desired by the Government would be 30 plus 48 or 78%.

Justice John Paul Stevens: Mr. Baker, the Government argues that precisely the same thing in essence would have happened if the loss that occurred in 1966, the same year in which the capital gain occurred.

What is your response to that argument as long as nine years (Inaudible)?

Mr. Russell W. Baker: Mr. Justice Stevens, that situation is what I often call the same year’s situation and it is the situation where a deficit in ordinary income occurs in the same year that one has a large capital gain and the Weil case which has been much mooted in arguments before this Court says, as it said in 1954 and so far as I know it is been uniformed with 1956.

It says that, "If it occurs in the same year, the one does not offset the other.

The full capital gain must be taxed under the alternative method and there is no reduction offered by reason of the deficit in ordinary income."

Now, the Tax Court has looked at this and it is found that the directions in the alternative tax statute on this very point are unqualified and has no choice.

This is what the unqualified directions of the statute say and therefore, there is no reduction in tax there, and I see a further question perhaps on your face or in your mind and that is, in such case is there a net operating loss to be carried over to another year.

The answer is there is not because subsection (c) and (d) of the statute tell just exactly how that is to be computed, so that in the same year situation, one must agree, that the loss disappears, it does a vanishing act.

Justice John Paul Stevens: Why should there be a different rule for a different year situation?

Mr. Russell W. Baker: Mr. Justice Stevens, the policies that have moved Congress to this are beyond my powers to detail to you, but may I say, that since 1918 when the prototype of the net operating loss statute came into our laws, that Congress has ever since then provided a different method of calculating the loss in the same year than it has in the carry year.

They have put a certain threshold on taxpayers which taxpayers must need in order to have in net operating loss, but once they pass that threshold, then Congress has always provided other casts in the carry years to see how much or what would be absorbed.

The policy implications of that, I cannot explain.

Justice John Paul Stevens: Well, does it not come down then to what do we really think the words that Congress use mean.

Shouldn't we not just net our cast to just read the language as carefully as we can?

Mr. Russell W. Baker: Yes and that is of course the task of the Court in this case.

What is the taxable income of each of the prior taxably years to which such loss maybe carried?

The Tax Court found that to which such loss maybe carried, results in a favorable result to the taxpayer here because it said, it modifies taxable income.

The taxable income to which it maybe carried and in that case, since in our case, the loss had not been carried against our capital gain at $35,000 not so carried was available for a carryover to another year.

So, of course it is the interpretation of that sentence of the statute, but may it please the Court, we would suggest that it is perhaps a little more than an exercise in a merely reading a sentence.

It perhaps requires the Court to examine the consequences of these interpretations.

If it finds the statute at all ambiguous to determine -- and the consequences may tell the Court some significant things about the possible intent of Congress.

I should like to follow the Government’s argument in describing the Chartier case which is the one which started this all off in 1969.

It maybe noted that the Government had not for many years before that and we have taken an administrative position on this point, but it did take a litigating position in Chartier.

Consequently the tax Court was the first court that got to speak on the problem.

There, as in our case, the taxpayer had a loss which he would carry to a year that had ordinary income and capital gain in it.

The loss wiped up the ordinary income but then there was some still left and in his first petition, the taxpayer said, “May I take this against the capital gain in computing the alternative tax?”

The Tax Court said, “No”, and as I was indicating in my answer to Mr. Justice Stevens, there is an unqualified direction in the statute to that affect.

The taxpayer then said “May I then carryover my loss to the next year and use it to reduce the ordinary income of that year to the extent, that there is some?”

The Government objected but over that objection, the Tax Court allowed this saying that the statute, the law statute, permitted this treatment.

Now, the Chartier Court is the only court which has had two petitions before it at the same time which it was confronted with both of these questions.

It answered the first one in favor of the Government and the second one for the taxpayer and it is the second one that the Government today wants overturn by this Court.

Justice Potter Stewart: The first one was what, the Weil case point?

Mr. Russell W. Baker: Yes Your Honor, the Weil case, it is -- one could say it is the Weil case all over again, but one also could say it was the first time that a court said, “Weil applies in the carry year,” but it is in effect Mr. Justice Stewart, the law doctrine in this first one.

We should like the Court to take note of certain irrationalities which we think are introduced by the Government’s position.

The government has to admit notwithstanding its argument against cumulating benefits, the government has to admit that in many cases, a taxpayer may use his net operating loss fully and also have the favorable rate on the capital gain.

What they claim is that in a few cases where the capital gain comes early in the prescribed eight year period, the absorption without tax benefit may take place, but they have to admit that if the capital gain comes a little later in this prescribed eight year period, giving enough time for ordinary income to accumulate in the first year or two, the loss will be applied against that ordinary income, the favorable rate will be available on the capital gains.

So, it is really a matter of accident within the prescribed period under the Government’s position.

They would treat the Foster class of taxpayers in a fluctuating fashion.

Some would have all of their loss allowed, some part of it, some get none of their loss allowed.

What this means to someone like respondent Foster Lumber Company is that according to the Government, Foster Lumber must waste $35,000 of its net operating loss because its capital gain occurred in the first of the possible years whereas its competitor across the street, identical in every way to Foster Lumber Company, can get the net operating loss and get the favorable rate on its taxable gain if only one thing is different and that is if the loss occurred in the second of the possible -- that the capital gain occurred in the second or later of the possible years.

Justice Byron R. White: The losses in carryback the loss and deducted against ordinary income?

Mr. Russell W. Baker: Yes, Your Honor.

Justice Byron R. White: Do you think that is irrational?

Mr. Russell W. Baker: Your Honor, if there is ordinary…

Justice Byron R. White: I mean every taxpayer who has ordinary income can use his loss to offset it?

Mr. Russell W. Baker: Mr. Justice White, that is not quite correct…

Justice Byron R. White: In any year that it is just carried over within the period.

Mr. Russell W. Baker: That, with respect, would not be true in our case.

Justice Byron R. White: So that is not that has been discriminated against, that is just that people who have or who just can not deduct it from capital gains, just as case is in the same year.

Mr. Russell W. Baker: With respect Mr. Justice White, I think there are cases where it cannot be deducted and I would suggest this to you that if in the first year there is only capital gain, the tax that the alternative tax right and in the next year then there is ordinary income, the loss carries back as absorbed to that tax benefit and under the Government’s position cannot be used in the second year.

Rebuttal of Unidentified Justice

Unidentified Justice: Because it has been fully absorbed under the first, under that position.

Rebuttal of Russell W. Baker

Mr. Russell W. Baker: Yes, under their position.

Rebuttal of Unidentified Justice

Unidentified Justice: Because their taxable income has been taxed at capital gains, right?

Rebuttal of Russell W. Baker

Mr. Russell W. Baker: Yes.

They say that absorbs the loss and our position is it does not.

Justice Harry A. Blackmun: Let me see if I have this straight.

Your position is that the irrationality of the Government’s posture is that the one purpose they take capital gains into account, for the other they do not.

Mr. Russell W. Baker: That would be one way of putting it Mr. Justice Blackmun.

Justice Harry A. Blackmun: Which reminds me of the badly drawn will, one can make arguments either way and there is illogic on both, each side of the case.

Mr. Russell W. Baker: I understand that.

Justice Harry A. Blackmun: Under that statute.

Mr. Russell W. Baker: That is certainly a way of putting it Mr. Justice Blackmun.

Justice John Paul Stevens: Mr. Baker, this is precisely the same irrationality as the distinction between the same year and the different year situation.

No one could give a hypothetical example showing that that is equally illogical and it does seem awfully illogical, I have to agree…

Mr. Russell W. Baker: I quite agree Mr. Justice Stevens that the same year situation is also illogical, but taxpayers have no argument there under the tax (Voice Overlap)...

Justice John Paul Stevens: ...because the language is unclear.

Mr. Russell W. Baker: ...because the language is clear.

Justice John Paul Stevens: But if you are arguing policy -- and what seems arbitrary and now you can make precisely strong an argument?

Mr. Russell W. Baker: You could indeed Mr. Justice Stevens and it is something that some day when Congress has time to think about things like that, then perhaps it will take care of.

It might be other systems on the point we are making and if there is any question in the Court’s mind about the discrimination between taxpayers of the Foster class to refer the Court again to the table on page 25 of our brief.

This tells what happens to the taxpayers in a way that exposition can hardly do.

It gives a general overview of the full nine year period involved, not with numbers, but with a plain statement of what happens to a net operating loss, when if it encounters the capital gain in any one of the eight carry years.

It states the Government’s position and our position for each year.

An examination of that table will show that the Government’s position gives eight different results in the carry years depending upon the timing of the capital gain, whereas our position gives a consistent result in all eight carry years regardless of the year in which the capital gain falls.

Now, we have included this table for the reason that if this Court discerns that one interpretation of the statute gives a crazy quilt pattern to taxpayers in this situation and another interpretation gives rise to a rational pattern, we think the Court will no doubt consider those results in selecting between the two interpretations.

Chief Justice Warren E. Burger: Do you think that contributes to the predictability of the situation?

Mr. Russell W. Baker: A judgment for us would certainly contribute to the predictability of the situation.

Yes Mr. Chief Justice.

Chief Justice Warren E. Burger: You have the consistent pattern in that.

Mr. Russell W. Baker: The Government filed a Reply Brief just before the hearing last year.

We have filed nothing in writing.

It was brought out in question by Mr. Justice Stewart with regard since that time.

I should therefore like to comment briefly, on certain points, on the points made in that Reply Brief.

First, the Government there said as it has said again today that the statute is clear and that policy and consequences should play little, if any, part.

Now, on this question of whether the Government’s reading of the statute is plain and clear as it insists, we think reference should be made to the period during which it has been litigating the question and the results it has obtained.

Perhaps I am repeating here, but I think it is worthy of emphasis that which was brought out on a question by the Court.

The Government took its first position in Chartier and lost in 1969 and as the government counsel indicated, it had fought for five years in the courts of this country to get a conflicting decision, and for five years the courts continued to rule without a dissenting vote that the language was either in favor of the taxpayer or was at least ambiguous, and they all ruled to the taxpayer.

Not until the Mutual Assurance case was handed down by the Fourth Circuit by a two to one vote that it obtained the conflicting decision that enabled the case to be brought here.

In view of that history, it is a little hard to accept the Government’s assertion that the reading of this statute is that plain and clear.

It seems to us that it is more fair to say that we are in an area of genuine dispute and we can look not only at the Tax Court for a serious opinion, but also at the opinion of the court below, the Eighth Circuit.

The Eighth Circuit found both readings of the statute to be equally plausible, but it selected the one that favored the taxpayer because, it said, “It was supported by the basic policy considerations underlying Sections 1201 and 172.”

We think the Court should realize that during the many years that the Government says this question has been open, the Government never before Chartier took a public position on it.

The examples in its regulations carefully avoid the problem.

The regulations are in effect in the language of the statute which does not advance the inquiry very much.

The examples might have held, but there is no example in the regulations which helps resolve this issue.

The IRS never published a ruling on this point.

In other words, it never communicated to Congress or to the public, any intimation of a view that losses could be absorbed by taxed capital gains.

Perhaps this is why Congress has never seen fit to clarify what now as a matter of controversy before this Court.

I should like to reply now to the Government’s assertion that the taxpayer would not have prevailed under the provisions of the 1939 Code.

Justice Lewis F. Powell: Mr. Baker, before you go on, prior to Chartier in the 1969, I think you said the Government had not undertaken any interpretation of this language in any official way.

How was the tax law enforced prior to 69 with Foster Lumber Company had been permitted by practice of the IRS to have carried the loss back as you now proposed to do?

Mr. Russell W. Baker: If I knew the answer to that Mr. Justice Powell, I would gladly give it you.

I imagine that the practice was variable.

I do not think the Government can state with any confidence that the practice was uniformly its way.

For example, prior to 1954 or as you corrected me perhaps 1956, the date of the Weil decision, it may not have even been clear to taxpayers that they could not deduct it from their capital gain, so they may have been taking it there until the Weil decision…

Justice Lewis F. Powell: In the same year…

Mr. Russell W. Baker: In the same year until that came about.

Beyond the Weil decision, I do not know what taxpayers were doing.

I think it is normal practice for accountants and tax advisers of corporations to advice their corporations where there is doubt about a matter to take to report it and favorably to themselves.

The Government did say with respect to the 39 Code, had a similar situation risen under that Code, the taxpayer would have lost.

That in 1954, when the Code section was rewritten, the addition of the words to which such loss maybe carried, they admit they were added at that time, but they say, they have no significance because the committee reports did not bring out what the addition of these words was intended to do.

We do not see any basis as I have indicated in my answer to the last question, we do not see any bases for the Government’s assertion that the taxpayer would not have prevailed under the 39 Code.

There is no decided case to that affect.

There is no ruling to that affect.

The same policy factors were acting then as now and there is a case in the amicus brief of the North River Insurance Company, Merrill against the United States which shows how the term 'net income', the term used instead of taxable income in the 39 Code, could have been construed so as to avoid the unnecessary wasting of the loss.

And when the Government asserts that the addition in 1954, the very words relied on the Tax Court are of no significance because the committee reports did not say anything about it, we feel that hardly need to reply.

Surely silence in the committee reports cannot properly be used to advance that argument.

We have analyzed the '54 rewrite and we have put the committee report side-by-side with them and we find at least two conspicuous changes made in Section 172 other than this one, which were not commented upon committee reports.

So, I do not think the Government should attempt to make too much out of a decision by a congressional committee to comment only upon those changes which they deem of general importance to large classes of taxpayers, but there is one aspect of the congressional history of the net operating loss provision which we would like to remind the Court of.

During the early new deal years, there was no net operating loss provision.

The Government needed the revenue to badly to have one.

Rebuttal of Unidentified Justice

Unidentified Justice: Mr. Baker could I stop you for a minute because I want to be sure I follow this one argument, I am not sure I do.

You say that the result under the 1939 Code is not clear.

They say it clearly would have gone for the Government and you say there are no decisions, but do you not rely on the words, to which such laws maybe carried to support your position and is it not correct that they were not a part of the 1939 statute, therefore, doesn't it follow that you would not had an argument under the language of 1939 statute?

Rebuttal of Russell W. Baker

Mr. Russell W. Baker: That is one way of putting it Your Honor.

In that case I would have retreated to the arguments of the Merrill case, case which I cited and argue of the policy factors in the construction of the word net income as that appeared in the 1939 Code.

Rebuttal of Unidentified Justice

Unidentified Justice: I see.

Thank you.

Rebuttal of Russell W. Baker

Mr. Russell W. Baker: The Revenue Act in 1939 introduced the modern net operating loss provision and it allowed two years in which you could carry a loss.

If you could not get your loss absorbed in those two years, it was gone forever.

Since then, they have been expanding this period.

We think that has significance.

There is only one reason why you expand the period for using losses and that so you can use them, so they will not die and be wasted.

In 1942, they expanded the period to four years.

In 1950, they expanded the period to six years.

In 1954, to seven years, in 1958 to eight years and yesterday when the President signed the Tax Bill, they had by the 1976 law expanded it to ten years for the carryover of a net operating loss.

We say this record exhibits a great and increasing concern by Congress that net operating losses be used and not be wasted.

I would turn now to a point which can strongly affect one’s view of the merits of this case.

In our brief we showed that under the Government’s position, Foster would be taxed on $396,000 over the three-year period, whereas everyone agrees that the aggregate taxable income for the period is $361,000.

The Government in its Reply Brief says, we are wrong about this.

Foster was not taxed on more than $361,000.

The dispute traces to one computation, the alternative tax in 1966 was 25% of the capital gain of a $167,000.

It is agreed that ordinary income was erased by the loss carryback, leaving only 25% capital gains tax to be paid.

If you multiply a $167,000 by 25%, you get the tax of 41,000 which we paid.

So, we say that $167,000 of capital gains has been taxed.

The Government Reply Brief says otherwise.

It says computing the tax on a $132,000 of taxable income by the alternative method, produced the tax of $41,000.

Is that true?

It does not sound right.

You take 25% of $132,000 and by ordinary arithmetic take that yields a tax in the neighborhood of $33,000.

So the $41,000 which we paid is the 25% tax on a $167,000 capital gain, as we argued.

To say that it's a tax on a $132,000 is plainly not so.

The Government brief does not show any explanation, metaphysical or otherwise to account for the inaccuracy.

So, we submit again as we did in our basic brief, that Fosters have been taxed on $167,000 of capital gain in 1966.

And if we must waste our loss as the Government contends, we will be taxed on $396,000 over the three-year period.

In the end, the Government’s attempt to force a wasting of loss in our circumstances is based more than anything else on its often repeated insistence regarding the meaning of the word 'carried', as it appears in the sentence of the statute.

If any court is qualified by close contact with the Internal Revenue Code to pass upon the meaning of the word 'carried' that should be the Tax Court.

We have mentioned throughout this argument, its pioneer decision in the Chartier case in 1969, the Tax Court has adhered to its reading of the word 'carried' in subsequent decisions.

As recently as 1974, in the Continental Equities case, it declined the Government’s request to reconsider Chartier and said, “We remain convinced of the soundness of Chartier and follow it in this case.”

May it please the Court?

Justice Harry A. Blackmun: It is reviewed by the full court, Chartier was not as I recall.

Mr. Russell W. Baker: I believe, not to my knowledge Mr. Justice Blackmun.

Justice Harry A. Blackmun: But in any event they are different judges, they are not all judged wrong?

Mr. Russell W. Baker: That is correct Your Honor.

Only Judge Raum wrote Chartier and another judge wrote Continental Equities and the other cases which followed.

May it please the Court; respondent asks that this Court affirm the judgment of the Eight Circuit Court of Appeals for the reasons mentioned in our brief and here today.

Chief Justice Warren E. Burger: Thank you, Mr. Baker.

Do you have anything further Mr. Smith?

You have about two minutes left.

Rebuttal of Stuart A. Smith

Mr. Stuart A. Smith: Two final points and this is my brother Mr. Baker has described in great length this array of decisions rejecting the Government’s position, but when stripping all that away, the only decision that comes, that attempted in detail to come to grips with the our position was the Tax Court’s original Chartier decision.

First Circuit affirmed Per curiam, the Ninth Circuit in Olympic Foundry affirmed Per curiam on the authority of the First Circuit, the Eighth Circuit in this case although it rendered a more lengthy opinion, when that opinion is analyzed in depth all it did was followed the other Circuits because it was impressed with the cumulative weight of the decision.

Rebuttal of Unidentified Justice

Unidentified Justice: Perhaps because they thought it was very simple.

Rebuttal of Stuart A. Smith

Mr. Stuart A. Smith: Perhaps, although we would submit that all of these courts were wrong, including the initial decision, as far as the administrative history of pre Chartier, I enquired at the Internal Revenue Service and they do not have any information about what was being done before, but I submit to the Court that since the regulations as promulgated in 1954, support the position that we are taking…

Rebuttal of Unidentified Justice

Unidentified Justice: Mr. Smith on the very point, your opponent says the regulations really just parrot the language of the statute that there are no examples in point, nothing really clarifying it.

Do you disagree with that?

Rebuttal of Stuart A. Smith

Mr. Stuart A. Smith: Well, I disagree in the sense that I suppose I would say that the language of the statute in our view, prescribes the very mathematical tests that…

Rebuttal of Unidentified Justice

Unidentified Justice: But, then the regulations really do not add anything to the Statute in my…

Rebuttal of Stuart A. Smith

Mr. Stuart A. Smith: The regulations do not add anything.

They do not add anything other than the statute, but I would submit that the revenue agents, we have no information that they were doing anything, but following the line.

There is no information at all.

As far as the Internal Revenue Service communicating its view as to the proper interpretation of the statute, it seems to us that the decision in Chartier and the appeal by the Government in the litigation that follows more than suffice to communicate to the private tax bar of the Government’s view that the Tax Court was wrong in Chartier and that those other Circuits were wrong as well.

Chief Justice Warren E. Burger: Thank you gentlemen.

The case is submitted.