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UNITED STATES v. CANNELTON SEWER PIPE CO.
(364 U.S. 76)
CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE
No. 513. Argued May 19, 1960,-Decided June 27, 1960. The Internal Revenue Code of 1939 permitted taxpayers to deduct as a depletion
allowance a percentage of "gross income from mining” and defined “mining" as including the “ordinary treatment processes normally applied by mine owners to obtain the commercially marketable mineral product or products.” Respondent mines fire clay and shale for which there is a market but which it utilizes to manufacture sewer pipe and other vitrified articles. It claims that it could not profitably market its raw fire clay and shale without processing them into finished products. Held: Respondent's depletion allowance must be based, not upon the value of the sewer pipe and other vitrified products which it manufactures but upon the value of its raw fire clay and shale after application of ordinary treatment processes normally applied in the recovery of these materials by miners not engaged in the manufacture of finished products. Pp. 77–90.
(a) Congress intended to grant miners a depletion allowance based on the constructive income from the raw mineral product, if marketable in that form, and not on the value of finished articles. Pp. 81-86.
(b) A depletion allowance is an allowance for the exhaustion of capital assets—not a subsidy to manufacturers or to high-cost mine operators. P. 86.
(c) That respondent is both a miner and a manufacturer does not entitle it to treatment different from that accorded miners of the same raw materials who are not manufacturers. Pp. 86–88.
(d) That respondent's underground method of mining prevents it from selling its raw fire clay and shale does not entitle it to treatment different from
that accorded to the other miners of the same raw materials. Pp. 88–89. 268 F. 2d 334, reversed.
 Ralph S. Spritzer argued the cause for the United States. With him on the brief were Solicitor General Rankin, Acting Assistant Attorney General Heffron, Mela M. Graney and James P. Turner.
Erwin N. Griswold argued the cause for respondent. With him on the brief was Howard P. Travis.
Robert E. Lee Hall and Richard L. Hirshberg filed a brief for the National Coal Association, as amicus curiae.
MR. JUSTICE CLARK delivered the opinion of the Court.
This income tax refund suit involves the statutory percentage depletion allowance to which respondent, an integrated miner-manufacturer of burnt clay products from fire clay and shale, is entitled under the Internal Revenue Code of 1939.1
1 The applicable provisions of the Code are $ 23(m) and § 114(b)(4). In general, they provide for a depletion allowance based on a percentage of "gross income from mining, which is specifically defined. See note 8, infra. The percentage permitted on shale is 5%, and on fire clay, 15%.
The percentage granted by the statute is on respondent's "gross income from mining.” It defines "mining” to include the “ordinary treatment processes normally applied by mine owners . . . to obtain the commercially marketable mineral product or products.” Ro
Respondent claimed that its first "commercially marketable mineral product” is sewer pipe and other vitrified articles. Alternatively, it contended that depletion should be based on the price of 80 tons of ground fire clay and shale actually sold during the tax year in question. The District Court agreed with respondent's first claim. The Court of Appeals affirmed, holding that respondent could not profitably sell its raw fire clay and shale without processing it into finished products, and that its statutory percentage depletion was therefore properly based on its gross sales  of the latter. 268 F. 2d 334. The Government contends that the product from which "gross income from mining” is computed is an industry-wide test and cannot be reduced to a particular operation that a taxpayer might find profitable. The Government further argues that, while the statute permits ordinary treatment processes normally applied by miners to the raw product of their mines to produce a commercially marketable mineral product, it does not embrace the fabrication of the mineral product into finished articles. In view of the importance of the question to taxpayers as well as to the Government, we granted certiorari. 361 U.S. 923. We disagree with respondent's contention that the issue is not presented by this record, and we therefore reach the merits. We have concluded that, under the mandate of the statute, respondent's "gross income from mining" under the findings here is the value of its raw fire clay and shale, after the application of the ordinary treatment processes normally applied by nonintegrated miners engaged in the recovery of those minerals.?
During the tax year ending November 30, 1951, the respondent owned and operated an underground mine from which it produced fire clay and shale in proportions of 60% fire clay and 40% shale. It transported the raw mineral product by truck to its plant at Cannelton, Indiana, about one and one-half miles distant. There it processed and fabricated the fire clay and shale into vitrified sewer pipe, flue lining and related products. In this process, the clay and shale is first ground into a pulverized form about as fine as talcum powder. The  powder is then mixed with water in a pug mill and becomes a plastic mass, which is formed by machines into the shape of the finished ware desired. The ware is then placed in dryers where heat of less than 212° is applied to remove all of the water. This process takes from 12 hours to 3 weeks, depending on the size of the ware. Thereafter the ware is vitrified in kilns at 2,200° Fahrenheit, requiring from 60 to 210 hours. It is then cooled, graded and either shipped or stored.
Not all clays and shales are suitable for respondent's operations. They must have plasticity, special drying qualities and be able to withstand high temperatures. Respondent's clay, known as Cannel
2 The quantity of ground and bagged fire clay and shale actually sold is too negligible to furnish an appropriate basis for computing depletion.
ton clay, is the deepest clay mined in Indiana and, respondent says, yields the best sewer pipe. Its costs of removing and delivering the same to its plant was $2.418 per ton in 1951. Respondent used some 38,473 tons of clay and shale in its operations that year and sold approximately 80 tons of ground fire clay and shale in bags at a price of $22.88 per ton. Net sales of its finished wares amounted to approximately one and a half million dollars.
In connection with its tax assessment for the year in question, respondent filed a document in which it stated that “we used as a basis for calculating the gross income from our mining operations of shale and fire clay the point in our manufacturing operations at which we first arrive with a commercially marketable product, which is ground fire clay. This product arrives after the raw mineral is crushed and granulated to such extent that by the addition of water it can be made into a mortar for use in laying or setting fire or refractory brick. This ground fire clay has a definite market and an ascertainable market value at any particular time and is the same product from which our end product, sewer tile, is made simply by the addition of water and the necessary baking process.” In this return it based the value of the ground  fire clay at $22.81 per ton, the price for which it sold some 80 tons of that material in bags during 1951. At this figure the depletion allowance would have been slightly above $2 per ton. Thereafter respondent claimed error and asserted that its mineral product, rather than being commercially marketable when it reached the stage of ground fire clay, only became commercially marketable when it became a finished product, e.g., sewer pipe. On this basis, the depletion allowance on petitioner's gross income would be approximately $4 per ton, since the mineral would have a value of about $40 per ton. On the other hand, if the mineral it used in 1951 was valued at $1.60 to $1.90 per ton, the going price elsewhere in Indiana, the depletion allowance would be approximately 20¢ per ton.
The record shows and the District Court found that in 1951 there were substantial sales of raw fire clay and shale in Indiana, mostly in the vicinity of Brazil, about 140 miles from Cannelton. The average price there was $1.60 to $1.90 per ton for fire clay and $1 per ton for shale. Transportation costs from Brazil to Cannelton ran from $4.58 to $5.50 per ton. In Kentucky, across the river from respondent's plant, it appears that fire clay and shale of the same grade were mined and sold s before, dur-  ing and subsequent to 1951. In fact, since 1957 respondent has secured all of its mineral requirements from this source on a lease basis under which the lessor mines and delivers the raw material to its plant. The exact cost is not shown, but the haul in 1957 from pit to plant, including the ferry crossing, was some seven miles.
8 The evidence indicates that, for $50, Owensboro Sewer Pipe Company bought from L. R. Chapman five acres of ground under which the shale and clay deposits lay. Contemporaneously it made a contract with L. R. Chapman, Inc., to mine and deliver shale and fire clay from this tract to the Owensboro plant for $1.40 per ton. Chapman also testified that in addition he furnished shale and fire clay to other manufacturers in the same area in Kentucky. The arrangements varied. Some were similar to the Owensboro agreement, while others were leases on a royalty basis with a contemporaneous agreement to mine and deliver the clay at a set price. The exact year or years are not clear, but appear to have been between 1949 and 1956. Respondent began using shale and fire clay from the same source by lease arrangement in 1957. The reason for lease arrangements and paper transfer of title is not shown. However, Chapman testified that the manufacturers "didn't seem to want to do the prospecting or the sampling until they were sure they could get either a lease or a deed."
We have carefully studied the legislative history of the depletion allowance. including the voluminous materials furnished by the parties, not only in their briefs but in the exhaustive appendices and the record.*. We shall not burden this opinion with its repetition.
In summary, mineral depletion for tax purposes is an allowance from income for the exhaustion of capital assets. Anderson v. Helvering, 310 U.S. 404 (1940). In addition, it is based on the belief that its allowance encourages extensive exploration and increasing discoveries of additional minerals to the benefit of the economy and strength of the Nation. We are not concerned with the validity of this theory or with the statutory policy. Our sole function is application of the congressional mandate. A study of the materials indicates that percentage depletion first came into the tax structure in 1926, when the Congress granted it to oil and gas producers. The percentage allowed was based on "gross income from the property,' which was described as “the gross receipts from the sale of oil and
gas as it is delivered from the property.” Preliminary Report, Joint Committee on Internal Revenue Taxation, Vol. I, Part 2 (1927). The report continued that, as to the integrated  operator, “the gross income from the property must be computed from the production and posted price of oil, as the gross receipts from a refined and transported product can not be used in determining the income as relating to an individual tract or lease." The Treasury Regulations confirmed
" this understanding. Treas. Reg. 74 (1929 ed.), Arts. 221(i), 241. .
Thereafter, in 1932, percentage depletion was extended to metal mines, coal, and sulphur. The mining engineer of the Joint Committee, Alex. R. Shepherd, urged in a report to the Congress that depletion for metal mines be computed, as in the oil and gas industry, on a percentage-of-income basis, and the Revenue Act of 1932 was so drawn. The Shepherd Report pointed out that the percentage basis for oil and gas depletion had been in force for over a year and had “functioned satisfactorily both from economical and administrative viewpoints and without loss of revenue.” It added that "careful study of this method as applied to metal mines indicates that the same results will be attained in practice as in the case of oil and gas,” but that, because of varied practices in the mining industry, it would be necessary to determine the point in accounting at which”
income from the property mined could be calculated. It recommended that "it is logical to peg ‘gross income from the property' f.o.b. cars at mine,” i.e., net smelter returns, recognizing that processing beyond this point should not be included in calculating "gross income from the property.” While as to certain metals, viz., gold, silver, or copper, the report suggested that gross income should be based on receipts from the sale of the crude, partially beneficiated or refined" product, this was but to make  provision for the specific operations of miners in those metals. In this regard the report also proposed that the depletion base "in the case of all other metals, coal and oil and gas, [should be] the competitive market receipts, or its equivalent, re
A The briefs cover 294 pages and the appendices an additional 685, not including 10 charts. The record is 276 pages.
6 Preliminary Report on Depletion, Staff Reports to the Joint Committee on Internal Revenue Taxation (1930), Appendix XXXI (Shepherd Report).
ceived from the sale of the crude products, or concentrates on an f.o.b. mine, mill, or well basis.”
The Congress in fashioning the 1932 Act took into account these recommendations. It incorporated a provision in the Act allowing percentage depletion for coal and metal mines and sulphur, based on the "gross income from the property.” § 114(b) (4), Revenue Act of 1932, 47 Stat. 169. On the following February 10, 1933, the Treasury issued its Regulations 77, which defined "gross income from the property" as "the amount for which the taxpayer sells (a), the crude mineral product of the property or (b) the product derived therefrom, not to exceed in the case of (a) the representative market or field price ... or in the case of (b) the representative market or field price
. of a product of the kind and grade from which the product sold was derived, before the application of any processes ; with the exception of those listed Treas. Reg. 77, Art. 221 (g). These exceptions listed processes normally in use in the mining industry for preparing the mineral as a marketable shipping product. The regulation was of unquestioned validity and, in 1943, at the instance of the industry, the Congress substantially embodied it into the statute itself, 58 Stat. 21, 44, including the basic definition of the term "gross income from the property. Since that time the  section on percentage depletion— 114(b) (4) (B) of the 1939 Code has remained basically the same. Additional minerals have been added from time to time-shale and fire clay in 1951—until practically all minerals are included.
As now enacted, the section provides that “mining” includes "not merely the extraction of the ores or minerals from the ground but also the ordinary treatment processes normally applied by mine owners or operators in order to obtain the commercially marketable mineral product or products,” plus transportation from the place of extraction to the plants or mills in which the ordinary treatment processes are applied thereto," not exceeding 50 miles. It then defines "ordinary
6 See, e.g., Hearings before Senate Committee on Finance on H.R. 3687, 78th Cong., 1st Sess. 528;
S. Rep. No. 627, 78th Cong., 1st Sess. 23-24; Hearings before House Committee on Ways and Means on Revenue Revisions, 80th Cong., 1st Sess., part 3, at 1857; Hearings before Senate Committee on Finance on H.R. 8920, 81st Cong., 2d Sess. 771; S. Rep. No. 2375, 81st Cong., 2d Sess. 53–54.
7 The present statute, § 613 of the Internal Revenue Code of 1954, is essentially unchanged.
8 Internal Revenue Code of 1939, 114(b) (4) (B): “Definition of Gross Income from Property.--As used in this paragraph the term 'gross income from the property' means the gross income from mining. The term 'mining as used herein shall be considered to include not merely the extraction of the ores or minerals from the ground but also the ordinary treatment processes normally applied by mine owners or operators in order to obtain the commercially marketable mineral product or products, and so much of the transportation of ores or minerals (whether or not by common carrier) from the point of extraction from the ground to the plants or mills in which the ordinary treatment processes
are applied thereto as is not in excess of 50 miles unless the Secretary finds that the physical and other requirements are such that the ore or mineral must be transported a greater distance to such plants or mills. The term 'ordinary treatment processes,' as used herein, shall include the following: (1) In the case of coal cleaning, breaking, sizing, and loading for shipment; (ii) in the case of sulphur-pumping to vats, cooling, breaking, and loading for shipment; (iii) in the case of iron ore, bauxite, bali and sagger clay, rock asphalt, and minerals which are customarily sold in the form of a crude mineral product-sorting, concentrating, and sintering to bring to shipping grade and form, and loading for shipment; and (iv) in the case of lead, zinc, copper, gold, silver, or fluorspar ores, potash, and ores which are not customarily sold in the form of crude mineral product--crushing, grinding, and beneficiation by concentration (gravity, flotation, amalgamation, electrostatic, or magnetic), cyanidation, leaching, crystallization, precipitation (but not including as an ordinary treatment process electrolytic deposition, roasting, thermal or electric smelting, or refining), or by substantially equivalent processes or combination of processes used in the separation or extraction of the product or products from the ore, including the furnacing of quicksilver ores. The principles of this subparagraph shall also be applicable in determining gross income attributable to mining for the purposes of sections 450 and 453." 26 U.S.C. (1952 ed.) § 114.