Transcript

IN THE SUPREME COURT OF THE UNITED STATES

COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. PORTLAND CEMENT COMPANY OF UTAH, Respondent

No. 79-1907

January 13, 1981

The above-entitled matter came on for oral argument before the Supreme Court of the United States at 2:16 o'clock p.m.

APPEARANCES:

STUART A. SMITH, Esq., Office of the Solicitor General, Department of Justice, Washington, D.C. 20530; on behalf of the Petitioner

DENNIS P. BEDELL, Esq., Miller & Chevalier, 1700 Pennsylvania Avenue, N.W., Washington, D.C. 20006; on behalf of the Respondent

PROCEEDINGS

MR. CHIEF JUSTICE BURGER: We'll hear arguments next in Commissioner of Internal Revenue v. Portland Cement Company.

I think you may proceed when you are ready, Mr. Smith.

ORAL ARGUMENT OF STUART A. SMITH, ESQ., ON BEHALF OF THE PETITIONER

MR. SMITH: Thank you. Mr. Chief Justice, and may it please the Court:

This income tax case comes here on a writ of certiorari from the United States Court of Appeals for the Tenth Circuit. The questions involve an application of a well established formula method set out in the Regulations for more than 40 years, for measuring the gross income from mining of a taxpayer who mines and thereafter produces a finished, manufactured product, the so-called integrated miner-manufacturer. The object of the formula which is called the proportionate profits method is to determine the price at which the taxpayer would have sold his mined ore to itself in a hypothetical sale, so as to confine the depletion deduction to its intended purpose of compensating for the exhaustion of the mineral deposit, the depletion deduction is a fixed percentage of gross income from mining. The method, the proportionate profits method is employed as it was in this case, where there is no representative field price or sales of -- actual sales at the cutoff point, at the point in which the mining activity ceases, or where there's -- essentially at arm's length. And the underlying theory of the proportionate profits method, which is a cost-ratio method, which is set out in our brief at page 3, it's a formula which essentially multiplies a fraction, the numerator of which is mining costs over total costs -- that is, mining plus non-mining costs, times the gross sales of the first marketable product which here is finished Portland cement and that figure --

QUESTION: May I interrupt you right there, that gross sales figure? That is the actual -- that isn't a constructed figure, is it?

MR. SMITH: No, not at all.

QUESTION: That is an actual figure representing the sales price of the finished product, whatever that product is?

MR. SMITH: Exactly, exactly.

QUESTION: Of the first marketable product?

MR. SMITH: Of the first marketable product.

QUESTION: And so that if it, normally, that price would be enough to cover all costs, anyway?

MR. SMITH: Yes.

QUESTION: Or they will go broke --

MR. SMITH: Yes, exactly.

QUESTION: So it's the gross sales price?

MR. SMITH: Exactly.

QUESTION: All right.

MR. SMITH: And the theory of the -- the underlying theory of the method is that each dollar of cost earns its proportionate share of gross sales and thereby, of profits. And the questions in this case are two, and they involve a -- they both involve detailed applications of the method.

The first question involves, is whether the gross sales figure, that is, the multiplier of the first marketable product includes bulk and bagged cement as the regulations require, or whether, as Respondent contends, simply bulk cement. And the second question involves the denominator of the fraction, that is, the total cost and whether the -- whether that denominator should include costs of bags, bagging, storage, distribution, and sales should be included as the regulations require.

QUESTION: While the two questions are separate, they are interrelated, are they not?

MR. SMITH: Absolutely, absolutely.

QUESTION: And they have to kind of be answered the same way?

MR. SMITH: Exactly, exactly.

QUESTION: Well, you couldn't lose the first question and still not change the denominator, could you?

MR. SMITH: No, no. While the questions are interrelated, I think the --

QUESTION: Well so if -- if your first marketable product is bulk cement, you're certainly not going to include in the denominator the cost of bagging?

MR. SMITH: No, exactly. The facts --

QUESTION: Let me ask one fact question, Mr. Smith.

MR. SMITH: Sure.

QUESTION: On his tax return, did the taxpayer, with respect to sales costs and office administrative costs, did the taxpayer seek to exclude them entirely or to place some of them in the numerator?

MR. SMITH: My understanding is that he sought to exclude them entirely; that's basically the position that the Court below, which as we set forth in our petition and in our brief, is really -- has been out of line with not only the regulations, but with all of the other Courts of Appeals.

QUESTION: Does the taxpayer take a different position on that than it did in the court below?

MR. SMITH: I think so. My understanding in looking at the briefs now, is the taxpayer is seeking a prorated --

QUESTION: Yes.

MR. SMITH: -- a prorated approach.

QUESTION: Well Mr. Smith, if the court below had agreed with you that the first marketable product was both bulk and bagged cement, I'm not sure it would have excluded any costs from the denominator.

MR. SMITH: Well, it's hard to tell. I mean, I can't put myself --

QUESTION: Well I know, but it said that the first marketable product was bulk cement --

MR. SMITH: Yes, yes, so it more or less then --

QUESTION: -- in this event, you should throw out some costs from the denominator.

MR. SMITH: Yes, and I --

QUESTION: So your first question, if you win on the first question, you win.

MR. SMITH: I think if I win on the first question, as a logical matter the second question is a subsidiary question which takes care of itself. But it's hard to know exactly how the court below felt about this question. Generally, because it had-- this question has been kicking around in the Tenth Circuit ever since the Ideal Basic case.

QUESTION: There's no suggestion that they would throw those costs out of the denominator even if --

MR. SMITH: No.

QUESTION: -- even if the first marketable product--

MR. SMITH: No, well what the Tenth Circuit has said, which we take strong disagreement with, is that the first marketable product was bulk cement. So let me just simply sketch out the facts which are relatively simple.

QUESTION: Which do they sell most of, by the way?

MR. SMITH: They sell mostly bulk cement, the bagged cement accounts for about 7 or 8 percent of its --let me put it this way, the cement in bags, it's the same product, it's whether it's sold in a railroad car, whether it's packed in bags, pursuant to particular kind of customer demand for cement in bags.

The facts are relatively simple. This respondent, like all others in the cement industry, is an integrated miner-manufacturer of Portland cement. The mining process involves a quarrying and a digging of this cement rock, it's a calcium carbonate kind of rock, it's reduced in size. It's then ground to a high degree of fineness, water is added, to produce something called the slurry. And then that slurry is stored in tanks and agitated to maintain uniform mixture until such time as it passes to the manufacturing process.

QUESTION: Mr. Smith, is it agreed that the mining phase stops at the point where slurry is --

MR. SMITH: Yes, I think that is -- that is agreed. Because the mining process, and Congress has, you know, ratified this in Section 613(c)(4)(f) which was enacted in response to the Court's Cannelton decision, the mining process stops at the kiln feed, everything after that is non-mining. And then this liquid slurry as I've averted is then fed into these rotary kilns which are fired and a hard substance called a clinker is ultimately formed, that clinker is cooled, ground up with purchased gypsum, to produce the finished cement. And then there is a final grinding and then the finished cement is stored in silos.

Some of the cement is sold in bulk in tankcars, or piggyback, or gondola cars, a variety of different forms for large consumers that need cement in that kind of quantity. But the important thing is that cement has to be kept dry, otherwise if it becomes wet it becomes worthless, so some people don't need that much cement and for those customers this manufacturer as well as all others in the integrated industry, pack the bag, pack the cement in bags of -- which are a standard 94-pound weight as I understand it.

QUESTION: Mr. Smith, I suppose it never happens, but suppose this manufacturer sold everything in bags, would you have a different case?

MR. SMITH: Then I would have a different case, but I don't think there would be a quarrel, I mean, essentially it would be the same marketable product; in our view, it would still be cement, the bagging costs would be a cost of sale and we would contend that that would be -- that would have to go into the denominator and the bagging --

QUESTION: So the Commissioner would take the same position that he took --

MR. SMITH: Right, but I assume that this taxpayer couldn't really argue that anything else was a first marketable product.

QUESTION: Mr. Smith, it has nothing to do with this case at all, but what's the difference between concrete and cement?

MR. SMITH: Concrete as I understand it -- and I should know this because I'm a city boy, I think is what happens when the cement is, you know, put in the building and it hardens. I think you talk about a concrete sidewalk, I don't think you talk about a cement sidewalk. But I could be wrong on that.

Well, this taxpayer, the Respondent computed its gross income from mining, in accordance with the proportionate profits method; indeed, it had to, because as I said, there is no representative field price, and it did not sell as -- nor did anyone in this industry, sell kiln feed, so there's no way to know how much kiln feed would sell for. But contrary to the command of the regulations, and I have to emphasize that these regulations which are set forth in detail and are the appendix to our brief, are detailed and more or less pre-empt this area, and pre-empt it in accordance with a command of Congress in Section 611(a), that the Commissioner promulgate such regulations, the Respondent computed its gross income by excluding bagged cement from the computation, and by excluding the costs of bagging, storage, distribution, and sales from the total costs element in the formula of the so-called denominator in that fraction.

The Tax Court in this case upheld the Respondent because the Tax Court has a rule in which it will follow the relevant circuit to which a case will go, the so-called Golsen rule. And since this Court of Appeals had already expressed itself, in the Ideal Basic case, that's why the Tax Court held the way it did and the Court of Appeals followed its Ideal Basic decision.

Now in our view with respect to the first question, the Respondent's first marketable product is finished cement, regardless of the form of packaging. As I said, the theory of the proportionate profits method is that each dollar of cost produces the same percentage of profits. To exclude any costs or any element through any aspect of gross sales received in production or sale of the first marketable product compromises the integrity of the formula.

QUESTION: Well what about the companies that sell on delivered price basis, and they pay for the transportation? You don't include transportation? You deduct transportation costs from gross sales price, don't you?

MR. SMITH: Only certain kinds of transportation, Mr. Justice White. The --

QUESTION: So long as you don't make a profit on it?

MR. SMITH: Well essentially, if they are delivered over to a transporter, it's the transporter's profit. That is an accommodation that the regulations make with respect to purchase --

QUESTION: So you do not include all elements of gross sales?

MR. SMITH: Well that as I understand it is the only element of gross sales that is not included.

QUESTION: Why isn't it included?

MR. SMITH: It's not included as I --

QUESTION: Because the company doesn't make a profit on it?

MR. SMITH: Because the company -- basically, because it's the transporter's profit.

QUESTION: Well, so yes, I'm right. The company itself doesn't make a profit on it?

MR. SMITH: The company does not make a profit on transportation, but --

QUESTION: Well what if it didn't make any profit on its bagging?

MR. SMITH: It -- well, I don't think we'd have to worry about that in this case, because --

QUESTION: I know you don't want to worry about it, but that's the very worry in the case.

MR. SMITH: No, it's not the very worry --

QUESTION: Well then it's one of them.

MR. SMITH: Well no it isn't, Mr. Justice White. And the reason it isn't, is because the Respondent -- because it's been stipulated in this case that the Respondent realized a net profit on the sale of each bag of cement and --

QUESTION: That is not, it is not stipulated that he made a profit on his bagging expense?

QUESTION: On the bags.

MR. SMITH: Well, if you -- yes, yes --

QUESTION: Is it?

MR. SMITH: It is not stipulated that he made a profit --

QUESTION: As a matter of fact, the claim is that he loses; that it costs him more to bag than he adds to the price from the bagging.

MR. SMITH: Yes. But the point of the proportion of profits method is that it has to measure the sales of a finished product. And part of the -- and this Respondent, as well as all other cement integrated producers sold bagged cement in response to a customer demand for cement in bags, and there is no suggestion here that -- and it seems to me, that the relevant fact is that this Respondent earned a profit on each bag of cement that it sold. And once it is assumed that that is a profitable aspect of its business, all of that has to go into the equation --

QUESTION: Except transportation because he doesn't make a profit on it?

MR. SMITH: Well except transportation, because transportation basically is taken out of his hands and put into the hands of the transporter and our point is with respect to transportation that I know that the --

QUESTION: The point is that he doesn't make a profit out of it.

MR. SMITH: Exactly, exactly. But he did make a profit on the sale of bagged cement, and I think that makes all the difference in the world.

QUESTION: I know you do.

MR. SMITH: The conditions of the regulation, the purchase transportation regulations, are set forth at page 13(a) of our appendix to our brief, and you can see that the conditions are very narrow. It says which -- it's not transportation conducted by the taxpayer, but which is performed in conveyances owned or leased by persons other than the taxpayer rather than conveyances owned or leased by the taxpayer, which are performed solely to deliver the taxpayer's minerals and mineral products to the customer rather than to transport such minerals or products from packaging or other additional processing which are charged to the customers in such a way that the taxpayer does not ordinarily earn any profit with respect to such transportation.

Now that is the, as I understand it, the only arguable exception to the integrity of the method, because the method demands that all -- the method won't work with respect to carving out that aspect of gross income from mining unless the denominator in that fraction includes all of the costs and the multiplier includes the gross income from mining. And since this taxpayer sold cement in bags and charged a price for it, that whole price has to be included because if it isn't, you don't get -- it's an approximated method but the approximation you know, starts to depart from the intended ambit of the depletion allowance which is to compensate for the exhaustion of the mineral deposit and not to compensate -- and not to provide any deduction for non-mining activities.

QUESTION: Well what if the taxpayer's price list said on it, I'll sell cement to you either in bags or in gross for exactly the same price per 100.

MR. SMITH: For exactly the same price per 100? Then I assume that, you know, people would either take it one way or the other. That doesn't mean the taxpayer is not making a profit of, or it means that he's selling bagged cement for less.

QUESTION: And so what if he's -- had a price system, says I'll sell you bulk cement for $2.00 and bagged cement for $2.10?

MR. SMITH: Yes?

QUESTION: And so it doesn't make any difference what his price list is. Or what the cost of bagging is.

MR. SMITH: No, it doesn't make any -- well, it does make a -- your example makes a difference, but the point is that his gross sale of his first marketable product in that -- in your latter example, is either $2.00 or $2.10. And we assume as --

QUESTION: And you said it wouldn't make any difference to your case if it were stipulated that the cost of bagging was $.20, would it?

MR. SMITH: It wouldn't make any difference to me, that the cost of bagging and in fact, you know, it was essentially that there was a disparity between the bagging premium and the bagging costs in this case. But essentially all that means is that he's selling the cement for less. I mean, we have to assume that this taxpayer sold bagged cement and you know, the Third Circuit more or less inferred that in Whitehall, and there's an array of appellate authority that rejects the notion that you can simply say well the bagging aspects of this thing are just an entirely different business, and that we're going to ignore them. Because the regulations provide with explicit direction that the first marketable product is cement, no matter how it is packaged, in either bulk or bagged form. Now if I can, to refer the Court to page 8(a) of our appendix, which says here the first marketable product means the product produced by the taxpayer as a result of the application of non-mining processes. And the formal condition in which such product or products are first marketed in significant quantities by the taxpayer, is meant with specific reference to the cement industry, they say here, for example, if a cement manufacturer sells his own finished cement of various types in bulk and bags, and also sells concrete blocks or dry ready-mixed aggregates, containing additives of finished cement of various types in bulk and bags, constitutes the first marketable product.

QUESTION: And your suggestion is that's a permissible construction of the statute?

MR. SMITH: Absolutely.

QUESTION: And that's -- if it isn't, you lose, but if it is, you should win?

MR. SMITH: I think we should win because the statute simply permits the Commissioner to permit the reasonable allowance in all such cases, being made under regulations prescribed by the Secretary or his delegate. Now that's a very broad delegation. We view those regulations as legislative in type, and this Court has held in cases which are legion, that the Commissioner's regulations are entitled to that --

QUESTION: What is the source of the language first marketable product?

MR. SMITH: What is the -- I assume that the source of the first --

QUESTION: Is that in the regulations anywhere?

MR. SMITH: Yes.

QUESTION: Is it in the statute?

MR. SMITH: It is not in the statute, but I assume that the --

QUESTION: So the first marketable product is a product of the Commissioner's mind?

MR. SMITH: Based upon his reading of this Court's decision in Cannelton Sewer Pipe, which talked about commercially marketable products.

QUESTION: Well isn't it a little strange to say that there are three products that are the first marketable product, even thought bulk cement, you have to do something else to it to get it into bags?

MR. SMITH: Put it in the bag, yes.

QUESTION: Well I know, but you have to do something else to it to get it into cement block.

MR. SMITH: Oh yes.

QUESTION: And it costs you money to do it, and yet you say all three are --

MR. SMITH: No, no, no. I -- that's not what I said, the block is not the first marketable product.

QUESTION: You said it was.

MR. SMITH: No, no, I didn't. Here also -- it says the finished cement of various types in bulk and bags, constitutes the first marketable product, but the blocks and the aggregates and the sakrete, or whatever, that's a different product.

QUESTION: What about the bagged cement? It's costing them money --

MR. SMITH: That's --

QUESTION: -- there's a whole, another process to go through to put it in bags.

MR. SMITH: Yes, Mr. Justice White --

QUESTION: And if so, how can there be two first marketable products?

MR. SMITH: Of course -- no, there's only one first marketable product. Cement, no matter how it is packaged.

QUESTION: I know that is what you say --

MR. SMITH: Yes. Because in our view, bagging is not a chemical or a physical process that adds, that alters the character of the manufactured product. The manufactured product is Portland cement, whether it's in a railroad car -- the Fifth Circuit stated this with excruciating detail -- whether it's in a railroad car, or piggyback, or whatever, it's still cement.

QUESTION: Well, Mr. Smith, is that consistent with the Tenth Circuit's opinion at 14(a) of the petition, down toward the bottom, where the Court there says the government seeks to have "bagged cement" be the "first marketable product" and to so include the expenses associated with the bagging. Did the government take the same position as the Tenth Circuit --

MR. SMITH: Oh well, that's really a mischaracterization of the government's position. The government argued that the first marketable product is finished cement, no matter how it's packaged. And I -- reading this most charitably, I would assume that what the Court meant is that government seeks to have bagged cement included in the first marketable product, because it's the same cement, it's simply put in a bag.

QUESTION: One answer might be that the reason you are here is because the Tenth Circuit, from your point of view, did not understand the case?

MR. SMITH: I think that's right. I mean, the Tenth Circuit took the position that bulk cement was the first product and bagged cement was the second product, but -- putting something in a bag is not the chemical or physical processing that the Court in Cannelton averred to when it tried to fix the cut-off point as to when mining stops and when manufacturing begins. And you know, the bagging is clearly part of the manufacturing cost, but it goes into the sales of what this Respondent and all other integrated producers sell as the first marketable product.

QUESTION: Mr. Smith, may I ask you a question prompted by some of Mr. Justice White's questions? As I understand your position, as a matter of fact you contend that the taxpayer actually made a profit on the bagged cement--

MR. SMITH: Yes.

QUESTION: They wouldn't sell it otherwise.

MR. SMITH: Yes.

QUESTION: But the profit on the bagged cement is less than the profit on the other cement because the bags are more --

MR. SMITH: Sure.

QUESTION: -- costly than the bagging premium. But is it not true that in your analysis of the case, even if they lost money on the bagged cement, say the bags were so terribly expensive -- packed them up in Christmas packages or something, they lost money on the bags, but you'd still make the same --same basic argument?

MR. SMITH: Sure, it would have to be included in the gross sales of the first marketable product. And then it would be, you know, it may affect the --

QUESTION: Just as -- well, from your point of view, just as if they'd maybe had a price cut during February, and they lost money for --

MR. SMITH: Sure, sure.

QUESTION: -- three or four weeks, then you would still use the same basic ingredients --

MR. SMITH: Exactly, exactly. And the suggestion, and the argument that I'm making is simply not one that's based upon regulations that we contend deserve great deference as legislative regulations. The Court has held in a variety of depletion cases, that the Commissioner has special powers in the depletion area because the legislative authority delegated -- the authority delegated to him is so broad, but the Respondent is faced with an array of appellate decisions in which the Court below stands as the sole exception, that the first marketable product in this area is bulk and bagged cement; that is, finished cement. I would like, since the second question is a subsidiary one, and I assume that costs necessarily included in the denominator flow from the first opinion -- from the first question, I would like to save my remaining time for rebuttal.

QUESTION: Well just one more question. Is your case really boiled down and perhaps oversimplified, something like the difference between buying a loaf of bread in Paris, where you put it under your arm, and buying one at the supermarket here, where it's all wrapped up in a package?

MR. SMITH: Exactly, it's the same bread. And if there are tax deductions that -- or computations that flow from that, that involve gross sales; if the supermarket in the United States has to sell some -- has to raise the price to take into account the bag, or if it doesn't those sales have to be included in gross sales.

And I'd like to save the rest of my time for rebuttal.

MR. CHIEF JUSTICE BURGER: Very well. Mr. Bedell.

ORAL ARGUMENT OF DENNIS P. BEDELL, ESQ., ON BEHALF OF THE RESPONDENT

MR. BEDELL: Mr. Chief Justice and may it please the Court:

The question in this case seems to have been cast in terms of preserving the integrity of a mathematical, automatically functioning formula rather than in terms of preserving the integrity of the purpose for which that formula is being applied. The purpose, the purpose is to ascertain an integrated miner's gross income from mining.

QUESTION: Well, let me put -- I am alternately confused and find the case simplified. When and what is it that can first be sold, what can first be sold here?

MR. BEDELL: Bulk cement. And bulk cement --

QUESTION: Is the case any more complicated than that?

MR. BEDELL: Not really. That is, that is the product that is sold in a substantial quantity. And indeed, as the Tenth Circuit has correctly recognized, bagging is something that occurs additionally and it has a discreet income component --

QUESTION: Well this sounds as though you agree with Mr. Smith, which I --

MR. BEDELL: I do not agree with Mr. Smith.

QUESTION: -- it sounds as though you do, though.

MR. BEDELL: No, --

QUESTION: You say bagged cement is not a -- one of the first marketable products, or even part of it?

MR. BEDELL: I certainly do, because bulk cement is sold in significant quantities.

QUESTION: More bulk than bag.

MR. BEDELL: Indeed. Approximately 95 percent in bulk. This is the first product --

QUESTION: Well now what if the situation were reversed, suppose there were more in bags than in bulk, only one percent of bulk, would your position here be exactly the same?

MR. BEDELL: No, it would not. Because you have to have sufficient sales to establish the price so that you have a meaningful first marketable product.

QUESTION. Well where is that --

MR. BEDELL: Just as in the case of our representative field price where the product is sold after mining ends --

QUESTION: Where is that line of demarcation, 50 percent, 40 percent?

MR. BEDELL: Cases in the depletion area under the representative market or field price generally are found 10, 15, 20 percent. It has to be determined with reference to the realities of the market.

QUESTION: What do you want to be included in your gross sales figure, the multiplier there? You just want the -- your gross sales of bulk cement in that or not?

MR. BEDELL: The sales figures should include the gross sales of bulk cement and the sales value of the cement which is sold in bags, because that also is the product of cement rock which was mined by the taxpayer and manufactured into finished cement.

QUESTION: So you say that -- you say, along with Mr. Smith then, that you include in the sales figures the cement sold in bags?

MR. BEDELL: You have to include an income figure for cement sold in bags, and the proportionate profit formula contemplates this, because it takes actual sales of the first marketable product, sales of cement in bulk and with respect to products that are second or third, a further processed or product after first marketable product, they take the constructed sales value derived from sales value applied to the first marketable product.

QUESTION: You used the word process, what was the process in putting it in the bag?

MR. BEDELL: It is the activity of putting it into a bag, Mr. Justice Marshall.

QUESTION: That's not a process is it?

MR. BEDELL: It is not in the sense usually used in the depletion area, it is not.

QUESTION: Mr. Bedell, on the portion of the gross sales that represent product that was bagged, what is the constructive sales price that the taxpayer contended for? Is it the equivalent of the unbagged cement, or is it the actual price less the bagging cost?

MR. BEDELL: The taxpayer took what is the less favorable position; namely, less favorable to itself, of the actual sales price less the bagging costs, because in this case, as the Court has noted, the bagging cost exceeded the bag premium and the additional revenue generated by selling the cement in bags rather than in bulk. So the taxpayer took sales figure of cement sold in bags, reduced that by the costs of bagging, which was greater really than the additional income generated by it, and put that in the sales figure that then was allocated in accordance with the proportionate profits formula.

QUESTION: It doesn't seem to me that's consistent with your basic position, that the sales cost is the cost of the unbagged cement. I mean, the sales price is the price of the unbagged cement. It may have been good tactics to do it that way, because I see what you're saying, but I think it's somewhat inconsistent.

MR. BEDELL: The taxpayer was following the law as had been set forth by the Tenth Circuit Court of Appeals, in 1968 in the Ideal Basic case. When interpreted the manner in which the proportionate profits formula functioned in the case of a cement manufacturer.

QUESTION: Do you agree, by the way, that the government's position is the one that the regulation commands? So you must attack the regulations?

MR. BEDELL: No, I do not agree with that. It seems to us that there is within the regulation, room to find a result which is consistent with the purpose of the regulation. The language Mr. Smith read to us which said that the bulk and packaged products are considered to be essentially the same product -- it doesn't say they are, it says they are considered to be -- that is language of presumption, not language of absoluteness. And when a result occurs under regulatory language, that clearly is at conflict with a purpose of the language, that it seems to me that this language is susceptible of being interpreted in a manner as to cure the distortion which will result under Mr. Smith's interpretation. And indeed, I think that distortion should be focused on, because it is material to realize the manner in which the purpose of the -- applying the formula is being frustrated. Let's return momentarily, the purpose is to determine the gross income from mining that is, the value of the taxpayer's mineral that could have been realized had it been sold after mining processes end, so we're looking to a market value for the raw mineral product. That's the purpose for which the formula is being applied.

QUESTION: And when did the process end, in your view?

MR. BEDELL: The mining process ends at the point of kiln feed -- when that is introduced into the kiln, there is no dispute between the government and the taxpayer with respect to that. But the taxpayer's cement rock, under the government's interpretation, would have one value, if that cement rock was manufactured into finished cement and sold as bulk cement. But a different value, the same identical mineral, would have a different value if it was manufactured into finished cement and sold in bags. Or look at it differently. In a given year, the taxpayer sold five percent of its cement rock in the form of finished cement in bags, the cement rock on an overall basis would have one value. The next year it sells 20 percent in bags from the same cement rock from the same quarry, assuming the same economic conditions, drops in value. On the other hand, if it went down to zero instead of seven percent it had here, the cement rock changes value. This is the identical mineral, which under the government's theory is having a change in value because of this bagging activity, an activity which occurs after all mining and all manufacturing processes have been completed.

QUESTION: What, to echo my brother Blackmun's question, what if your client sold all his cement in bags, and always had and always will?

MR. BEDELL: If all the cement were sold in bags, bagged cement would be the first marketable product, because what is being --

QUESTION: And bagging would clearly be part of the --

MR. BEDELL: Then bagging would be part of the costs in arriving at that. But what is being looked to is what is the point in the activity of getting to market when the taxpayer --

QUESTION: What if a competitor sold all his cement in bulk? The difference of the mined product would be different between the two companies, wouldn't it?

MR. BEDELL: Under --

QUESTION: Although it would be an identical product.

MR. BEDELL: Under the proportionate profits formula, yes.

QUESTION: To carry it one step further, what if the industry as a whole sold largely or totally in bulk? And this one manufacturer sold it just in bags?

MR. BEDELL: There would be -- because of the manner in which the formula, mathematical formula operates, there would be a different result. Now the question is, in this case, there are actual facts --

QUESTION: Right.

MR. BEDELL: There are actual facts which can be looked to, to avoid what is an unrealistic result from the application of mechanical formula. And that really is the question: can actual facts be taken into account? The bagging cost and the amount of additional income because it is clear, on the record, that the taxpayer realized a certain increment of revenue when it sold cement in bags rather than in bulk. An additional amount of revenue.

QUESTION: Well how is that different from, say, you have three or four methods of sales. Some you sell through distributors and some on commission, and some through door-to-door salesmen, and there are different sales costs for ten percent of your business and another 20 and another 50, but still all cement. Would you -- and those proportions vary from year to year, the value of the mined product would also vary from year to year, I suppose, would you say that nevertheless, those are -- would you say that's all one marketable product, or does it change from time to time? Say that none of it was in bags but some of it was sold in smaller quantities at somewhat different prices because different sales techniques -- How is that any different than the bagging problem?

MR. BEDELL: One -- since the -- well, it seems to me it is different in two reasons, because in the first, there may be sales much closer to the manufacturing plant itself, and so --

QUESTION: I'm leaving out transportation because I'm just working on sales price.

MR. BEDELL: The other, the other thing is that sales costs, sales costs are costs which a number of the Courts that have looked at it, the lower Courts, have decided are cost allocable both to the mining and the manufacturing activity.

QUESTION: Well that's exactly what -- say the bags are allocated to both, too.

MR. BEDELL: Right, they allocate -- well, the government though, under its interpretation of the formula would allocate the cost of bagging solely to the manufacturing non-mining side.

QUESTION: Well, Mr. Bedell --

QUESTION: That goes into the total figure, doesn't it? Just as the sales costs go into the total figure. Maybe I'm wrong, but I thought that -- say you have a general sales manager, where is his salary?

MR. BEDELL: The salary of a general sales manager should be treated as both in the numerator of the formula and in the denominator.

QUESTION: Is that what you did in your tax return?

MR. BEDELL: Again, following the Tenth Circuit, the Tenth Circuit interprets --

QUESTION: Yes, or no, did you or did you not?

MR. BEDELL: No. Because that is not the matter which the Tenth Circuit interprets.

QUESTION: If one reads the statutory language itself, 611(a), the general rule, in talking about mines, it says that the -- a large depletion for depreciation improvements according to peculiar conditions in each case. Such reasonable allowance in all cases to be made under regulations prescribed by the secretary or his delegate, is it conceivable in view of that reference to peculiar cases that the numerator/denominator worked out by the secretary could itself be unreasonable in some cases?

MR. BEDELL: Exactly, exactly. It is contemplated by the statute, not only by the language that it be reasonable but that it take into the account the variation in different cases.

Obviously, administrative convenience and simplicity require ignoring some variations, but when you have variations that are supported by definite facts such as in this case, peculiar circumstances, what we have here, ascertainable income items and ascertainable costs associated with the bagging activity, then that is the type of case which it should be dealt with.

And indeed that is what the Tenth Circuit has consistently held, the Ideal Basic case in 1968, the Portland Cement Company of Utah case in 1979, and then in this case. Because this actual fact, it is a factor which can be taken into account and supports the determination as the Tenth Circuit has held that the first marketable product was cement in bulk.

The confusion between the premise, the premise of the proportionate profits formula and the purpose which it serves of trying to find gross income for mining, has clouded the issue and in many contexts that's been looked at up until now.

There is distortion which occurs if additional processes bar their way from the crude mineral product which is being valued or taken into account. The Tenth Circuit realized that, and the Tenth Circuit because it realized the purpose of the proportionate profit formula, is to value the mineral product found the place closest to the mine, closest to the point where the mineral product is, and that is cement in bulk. And treated that as the first marketable product so that it was the starting point for the application of this mathematical formula to ascertain the market value, it did away with the recognized distorting effects which occur if additional activities on which a profit is not earned are included in the computation in the same manner as the regulations explicitly recognize with respect to purchased transportation. Purchased transportation by common carrier to the customers, to deliver the material to the customer is specifically excluded. Why, because there is a reason. It is not reasonable to presume that the miner earns a profit on the transportation, because the carrier earns it. Evidence of a tariff demonstrates that. Here, the facts, the evidence of the bagging premiums and the bagging costs demonstrate that it is not appropriate to attribute any further profit to the bagging activity. And so the Tenth Circuit excluded that from the computation in a similar manner by its determination that the first marketable product is cement in bulk. The result of making the proportionate profits method work in the best manner it can, to serve its purpose, can be accomplished as the Tenth Circuit did or by finding implicit in the regulatory language flexibility to make its application a reasonable one, one consistent with the actual facts. I thank the Court.

MR. CHIEF JUSTICE BURGER: Very well. Mr. Smith, do you have anything further?

ORAL REBUTTAL ARGUMENT OF STUART A. SMITH, ESQ., ON BEHALF OF THE PETITIONER

MR. SMITH: I think that the Respondent's emphasis on actual facts is belied by the provisions of the regulation which provide that the Commissioner may determine that a method of computation is more appropriate than the proportionate profits method or the method being used by the taxpayer, and that the taxpayer can request such a determination, of an alternative method.

Here, the taxpayer has, because of its integrated status and the absence of a representative field price, has invoked the proportionate profits method of computing its gross income from mining. It hasn't sought to bring any actual facts to the Commissioner before going into this litigation. The proportionate profits method provides in detail as in the language I read to the Court about a cement manufacturer and we talk about the flexibility of the regulations. The regulations provide at page 21(a) of our appendix with precise reference to this case, if a cement manufacturer et cetera, et cetera. There was no room for any flexible reading, what the Respondent seeks in this case is nothing less than an invalidation of these regulations which three Courts of Appeals have approved and which the Court below stands in sole and persistent invalidation of and there's no way that one can read these regulations in a flexible way to take account of what Respondent seeks in this case, which in our view is nothing less than an expanded depletion allowance that would include part of its non-mining income.

The cost ratio method is indeed an approximation, but it is an approximation which is designed to take into account the fact that each dollar of costs produces a proportionate amount of gross sales --

QUESTION:. Well that in itself is something of a fiction.

MR. SMITH: Well of course it's a fiction, but --

QUESTION: Or at least --

MR. SMITH: -- it's an approximation which is based upon the fact that there's no really better way to do it, and regulations like that, the choice that the Commissioner makes in areas like technical area like depletion, and in other areas of the Code, has been consistently upheld by this Court and by the Court and basically --

QUESTION: Your point is that this taxpayer elected to proceed under --

MR. SMITH: Elected the proportionate profits method and you can't simply elect parts of the proportionate profits method. Putting a cement -- putting cement in a bag is, in our view and in the view of the regulations, not processing. It doesn't alter the character of the cement, the cement whether it's in a tankcars or whether it's in a bag, is still Portland Cement. That was the Respondent's first marketable product and the gross sales of those things -- if the taxpayer had sold Portland Cement at a great killing at a very high price, whether it would still be in gross sales -- in other words, you know, it may produce some variations or some distortions, or if the market goes down it would still be in gross sales. And the fact that, you know, it sought to satisfy a particular kind of demand of small customers in the construction industry for 94 pounds, bags of cement, that was part of its business.

QUESTION: Did you say that --

MR. SMITH: And if it's part of its business --

QUESTION: Did you say for the same reason that sales expense after bagging is included?

MR. SMITH: Sales expense after bagging to get it to the customer is -- goes into the denominator, exactly.

QUESTION: For the same reason, the same reason.

MR. SMITH: Exactly, exactly. And for all -- for all those purposes we think think that the judgment should be reversed. Thank you.

MR. CHIEF JUSTICE BURGER: Thank you gentlemen. The case is submitted.

(Whereupon, at 3:04 o'clock p.m. the above matter was submitted.)