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UNITED STATES GYPSUM COMPANY v. UNITED STATES

March 6, 1962

UNITED STATES GYPSUM COMPANY
v.
UNITED STATES OF AMERICA.



The opinion of the court was delivered by: Julius J. Hoffman, District Judge.

  The plaintiff, United States Gypsum Company, seeks a refund from the defendant, United States of America, of a portion of the federal income taxes, together with interest thereon, which it paid for the years 1952 and 1953. The plaintiff filed two actions in this court, concerning its claims for refunds for 1952 and 1953, respectively. The actions were consolidated for trial.

The court has jurisdiction over this cause pursuant to 28 U.S.C. § 1346(a)(1). The plaintiff has filed proper claims for refunds of the taxes here involved with the Commissioner of Internal Revenue. These claims have been pending before the Commissioner for more than six months, and no action has been taken with respect to the allowance of the claims here in controversy. The plaintiff, therefore, has met the requirements of 26 U.S.C. § 3772(a)(1) & (2).

       I. STIPULATIONS AND OTHER AGREEMENTS REACHED BY THE
                            PARTIES.

In the course of the proceedings before this court, the parties have reached agreement concerning certain claims of the plaintiff, as follows:

(1) The parties stipulated, prior to trial, that the plaintiff has withdrawn a claim for a deduction as a current expense of the cost of a Euclid truck purchased in 1952 for $24,551. This claim was included in error in the complaint in case number 58 C 1811.

(2) The parties stipulated in the course of the trial that the plaintiff has received a refund from the Commissioner of Internal Revenue in the amount of $495,366.46, in settlement of the plaintiff's claim in case number 58 C 1811 that it was entitled to a depletion deduction for the year 1952 equal to five per cent of the gross income from its mines and quarries, under section 114(b)(4)(A)(i) of the Internal Revenue Code of 1939, 26 U.S.C. § 114(b)(4)(A)(i). That claim, therefore, is no longer at issue in this case.

(3) The parties stipulated at the outset of the trial that the plaintiff has withdrawn its claim for a depletion deduction on its limestone quarry at Farnums, Massachusetts, at the rate of fifteen per cent, as chemical grade limestone, instead of at the rate of ten per cent, as calcium carbonate.

(4) The parties further stipulated before trial that the plaintiff is entitled to a reduction of its taxable income for the year 1953 in the amount of $517.61, which represents the excess which the plaintiff received over the purchase price on the sale of certain treasury stock. The defendant specified that it agreed to the plaintiff's right to this deduction for purposes of this action, only.

(5) The parties further stipulated before trial that the plaintiff is entitled to a deduction from gross income of $1,387.29, for certain state taxes paid by the plaintiff based upon income applicable to the year 1953. The defendant specified that it agreed to the plaintiff's right to this deduction for purposes of this action, only.

(6) Subsequent to the trial, the defendant agreed that the plaintiff is entitled to a depletion deduction from gross income, under section 114(b)(4)(A)(i) of the Internal Revenue Code of 1939, for the year 1953, equal to five per cent of the gross income from the thirteen gypsum mines and quarries which the plaintiff operated during that year. In United States Gypsum Co. v. United States, 253 F.2d 738 (7th Cir. 1958), the Court of Appeals for the Seventh Circuit affirmed a ruling of the District Court for the Northern District of Illinois that these same thirteen mines or quarries of the plaintiff were entitled to a five per cent depletion deduction under section 114(b)(4)(A)(i) for the year 1951.

The uncontroverted evidence of the plaintiff at the trial established that during the tax year ended December 31, 1953, the plaintiff was engaged in the mining of these thirteen natural mineral deposits of gypsum, and the gypsum extracted from these mines during 1953 was of the same quality and nature as that extracted from its mines in 1951 and 1952. During 1953, the plaintiff mined a total of 4,267,183 tons of gypsum rock, resulting in gross income from mining of not less than $13,385,575, on account of which the plaintiff realized net income from mining of $4,595,015. For the tax year ended December 31, 1953, the plaintiff claimed, and the Commissioner of Internal Revenue failed to allow, a deduction of $622,100 under section 23(m) of the Internal Revenue Code of 1939, 26 U.S.C. § 23(m), as amended, pursuant to the percentage depletion allowance provision of section 114(b)(4)(A)(i).

On the basis of the plaintiff's evidence, and under the authority of United States Gypsum Co. v. United States, supra, the plaintiff's gypsum is "stone" within the meaning of the percentage depletion allowance provisions of section 114(b)(4)(A)(i) of the Internal Revenue Code of 1939; that this provision is applicable to the computation of the plaintiff's federal income tax liability for the tax year ended December 31, 1953; and that the plaintiff should have been permitted to deduct from gross income, on account of percentage depletion allowance, $622,100 under section 23(m) of the Internal Revenue Code of 1939.

(7) Subsequent to the trial, the defendant agreed that the plaintiff is entitled to a deduction from gross income of $20,244 for the year 1952 for the purchase of a fifteen ton truck for its mine at Southard, Oklahoma.

Testimony of the plaintiff's witness Appleyard established that the recession of the working faces in the lower strata of the deposit at the Southard mine had increased the haulage distance between those working faces and the plaintiff's main plant, and the purchase of an additional truck was required to maintain the normal rate of output from this strata, despite the increased haulage distance from the working faces to the crushing plant. This expenditure was necessitated solely because of the recession of the working faces of the mine, and did not increase the value of the mine, decrease the cost of production of mineral units, or represent an amount expended in restoring property or in making good the exhaustion thereof for which an allowance is or has been made. Consequently, this expenditure qualifies as an ordinary and necessary business expense under section 39.23(m)-15 of Treasury Regulations 118, under the Internal Revenue Act of 1939.

        II. ITEMS IN CONTROVERSY CLAIMED AS RECEDING FACE
                 EXPENDITURES BY THE PLAINTIFF.

The claims of the plaintiff that remain in issue concern expenditures for equipment for various of the plaintiff's mines and quarries. The plaintiff asserts that these expenditures qualify as ordinary and necessary business expenses under Treasury Regulations 118, section 39.23(m)-15 (Internal Revenue Code of 1939). The defendant, on the other hand, contends that they fail to qualify as receding face expenses.

The applicable Treasury Regulation provides as follows:

    "Sec. 39.23(m)-15. (As amended by T.D. 6096,
  1954-2 Cum.Bul. 69.) Allowable Capital Additions in
  Case of Mines. — (a) General Rule. — Expenditures
  for plant and equipment and for replacements, not
  including expenditures for maintenance and for
  ordinary and necessary repairs, shall ordinarily be
  charged to capital account recoverable through
  depreciation. Expenditures for equipment (including
  its installation and

  housing) and for replacements thereof, which are
  necessary to maintain the normal output solely
  because of the recession of the working faces of
  the mine, and which (1) do not increase the value
  of the mine, or (2) do not decrease the cost of
  production of mineral units, or (3) do not
  represent an amount expended in restoring
  property or in making good the exhaustion thereof
  for which an allowance is or has been made, shall
  be deducted as ordinary and necessary business
  expenses."

It is useful to consider this regulation against the background of the relevant provisions of the Internal Revenue Code of 1939.

Section 23(a)(1) thereof provides that in computing net income there shall be allowed as deductions "All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business * * *." Section 24(a), 26 U.S.C. § 24(a) provides that in computing net income no deduction shall be allowed in respect of "(2) Any amount paid out for new buildings or for permanent improvements or betterments made to increase the value of any property or estate except expenditures for the development of mines or deposits deductible under section 23 (cc); (3) Any amount expended in restoring property or in making good the exhaustion thereof for which an allowance is or has been made * * *."

Section 23(cc), added to the Code by the Revenue Act of 1951, 65 Stat. 452, 26 U.S.C. § 23(cc), allows as deductions "(1) * * * all expenditures paid or incurred during the taxable year for the development of a mine or other natural deposit (other than an oil or gas well) if paid or incurred after December 31, 1950, and after the existence of ores or minerals in commercially marketable quantities has been disclosed." The section, however, specifies that it "shall not apply to expenditures for the acquisition of or improvement of property of a character which is subject to the allowance for depreciation provided in section 23 (l), but allowances for depreciation shall be considered, for the purposes of this subsection, as expenditures." Subsection (2) of this provision permits the taxpayer to elect to treat development expenditures as deferred operating expenses, deducted ratably as the units of produced mineral benefited by the expenditures are sold. Section 23(l), referred to in section 23(cc)(1), provides for "A reasonable allowance for the exhaustion, wear and tear (including a reasonable allowance for obsolescence) — (1) of property used in the trade or business, or (2) of property held for the production of income."

These various provisions, read together, show a certain pattern in the treatment of depreciable mining property. Ordinary and necessary expenses of a business are deductible as current expenses, but buildings or improvements made to increase the value of any property are not deductible. Mine development expenditures are deductible, but this provision expressly excludes depreciable property. However, section 39.23(m)-15, Treasury Regulations 118, quoted previously, allows a deduction as an ordinary and necessary business expense for expenditures for equipment, and for replacements thereof, necessary to maintain the normal output of a mine solely because of the recession of the working faces of the mine, and which do not increase the value of the mine, or do not decrease the cost of production of mineral units, or do not represent an amount expended in restoring property or in making good the exhaustion thereof for which an allowance is or has been made.

  It should be noted that prior to 1951 mine development costs
incurred prior to the production stage of the mine were not
deductible as ordinary and necessary business expenses.
Section 29.23(m)-15 of Treasury Regulations 111, applicable to
years prior to 1951, provides that "(a) All expenditures in
excess of net receipts from minerals sold shall be charged to
capital account recoverable through

depletion while the mine is in the development stage." After
the production stage of the mine was reached, development
expenditures, made to maintain the output of the mine, were
deductible as operating costs. Clear Fork Coal Co. v.
Commissioner, 229 F.2d 638 (6th Cir. 1956), reversing 22 T.C. 1075
 (1954). Such expenditures were generally treated as
deferred costs, deductible in the years in which the ore
benefited by the expenditures were produced and sold. See
G.C.M. 13954, XIII-2 Cum.Bul. 66, 72 (1934); Alexander &
Grant, "Mine Development and Exploration Expenditures," 8 Tax
L.Rev. 401, 414 (1952-53); Carson, "Tax Problems of the Mining
Industry," Proceedings of New York University Ninth Annual
Institute on Federal Taxation 319, 335 (1951). Since 1951,
development costs incurred both before and after the
production stage is reached have been deductible as expenses.
§ 39.23(cc)-1, Treasury Regulations 118.

Provisions relating to development are described above in order to show the general legislative treatment with respect to mine expenditures. On the one hand, mine development, both before and after the production stage, is given special, liberal treatment by the Revenue Act of 1951. On the other hand, depreciable mine property has received special treatment as deductible expenses only under the specific conditions set forth in section 39.23(m)-15 of Treasury Regulations 118, originally promulgated in art. 242(b) of Regulations 77 (1933 ed.) under the Revenue Act of 1932. Congress has not seen fit to change these conditions in the course of liberalizing the treatment of development expenditures, and we may consider that it has approved the case law and regulations bearing upon expenditures for depreciable property in mining.

The evidence concerning the expenditures in question was presented by the plaintiff's witness Appleyard, its manager of mines. Appleyard has been in the plaintiff's employ for twenty years and is a mining engineer of considerable experience. One of his duties as manager of mines for the plaintiff is to make the final decisions on expenditures for equipment with regard to recession of mine faces.

The defendant introduced no evidence, insisting that the plaintiff has failed to establish a prima facie case for recovery.

Plasterco, Virginia Mine

  1. 1953 expenditure for construction of a new ore
        pocket: $118,130.
  2. 1953 expenditure for a new hoist motor and
        skips: $59,801.

During the tax year 1953, the plaintiff owned and operated a gypsum mine at Plasterco, Virginia, and during 1953, the plaintiff expended $118,130 for the construction of a new ore pocket and $59,801 for a new hoist motor and skips at the Plasterco mine.

The Plasterco mine is an underground mine having a main vertical shaft and horizontal tunnels which extend out from the main shaft at various levels. In 1952-53, the main shaft was extended downward from the sixth level to what is now the ninth level, because the gypsum mined at the upper levels was nearing depletion.

In order to mine at the new levels, it was necessary to excavate a new ore pocket at the ninth level. An older ore pocket, located just below the sixth level, could not serve the mining at the levels below. The ore pocket is used to hold the gypsum mined from the working faces. The gysum is transferred from the ore pocket to skips and hoisted to the surface.

The new ore pocket at the ninth level was two hundred feet below the location of the old pocket; consequently, to compensate for the time lost in hoisting from the lower level, it was necessary to install a faster, larger motor on the hoist and to redesign the skips to move up and down faster and dump faster at the top.

The defendant contends that these expenditures fail to qualify as receding face deductions for two reasons: (1) They were not necessitated because of the recession of the working faces of the mine, but rather because the mining was proceeding into a "new area." The defendant maintains that expenditures for the mining of "new areas" cannot qualify under the regulation. (2) The plaintiff has failed to establish a prima facie case that the expenditures did not increase the value or productive capacity of the mine.

(1) Recession of the working faces. With respect to the first contention of the defendant, the expenditures seem clearly to fall within the ambit of Marsh Fork Coal Co. v. Lucas, 42 F.2d 83, 84 (4th Cir. 1930).*fn1 The Marsh Fork was is recognized as the leading case in this area and is the case upon which the treasury regulation was originally promulgated.

In Marsh Fork, the late Judge Parker held that expenditures for electric locomotives, mine cars, and steel rails were deductible from gross income for the year in which they were purchased, where the purchase of the equipment did not add, and was not intended to add, anything to the value of the mining property, its purchase was made necessary by the removal of the coal and the recession of the working faces, and its installation was merely an expense incident to the removal of the coal. In so holding, Judge Parker stated, in part, the following:

    "Ordinarily it is true that the purchase of
  machinery having a life greater than one year is
  to be charged to capital and not to expense, for
  ordinarily such machinery is purchased either to
  increase production or to decrease cost and in
  either event to add to the value of the property.
  Expenditures such as those here involved,
  however, are not made either to increase
  production or to decrease cost of operation. They
  do not add to the value of the property, and are
  not made for that purpose. They are made solely
  for the purpose of maintaining the capacity of
  the mine as the working faces of the coal recede.
  They represent the cost, ...

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