Swygert, Chief Judge, Pell and Sprecher, Circuit Judges.
This case concerns the correct method of computing the gross income from mining of taxpayer, an integrated miner-manufacturer of limestone products, for depletion allowance purposes. Because the taxpayer in the taxable years sold only a small quantity of rough block limestone from its mines and shipped the rest to its mills for fabrication processing, it must compute its mining income "constructively" according to Treasury Regulation § 1.613-3 and its predecessor. The district court, 315 F. Supp. 1255, found that the taxpayer had established "representative market or field prices" for the various grades of raw limestone. The government contends that it is impossible to establish such representative prices because of the variation of quality within each grade, and insists that the taxpayer must use the alternative proportionate profits method. If the taxpayer did establish representative market or field prices, the government argues that the prices it used are invalid under the presumption of § 1.613-3(c)(6), or were computed incorrectly.
The taxpayer, Bloomington Limestone Corporation, brought this suit in the district court for the refund of income taxes paid for the years 1955, 1956, and 1958, a total of $75,153.70 plus interest. The government had disallowed deductions from taxpayer's gross income for 1958 and 1959, claimed as the mining depletion allowance under 26 U.S.C. § 611(a).
The applicable regulation, 1.613-3(c) (1),*fn1 allows the taxpayer to fix the price at which it could have sold its ore, before the application of nonmining processes, through the use of actual sales by the taxpayer or its competitors. Oolitic limestone is sold in Indiana according to a grading system adopted by the Indiana Limestone Institute. The classifications are based on color and texture of the stone, as well as on length and clarity. "Long length" refers to stone five feet or longer without seams or flaws. "Short length" or "cull" stone is either clear but shorter than five feet, or longer but with one seam in the block. "Housing" stone is a five-foot block with more than one seam, or a shorter block with any seams.
The government challenges the adequacy of the grading system to meet the requirement of the regulation that the representative price be based on the sale of ore of "like kind and grades." Section (c)(2) of the regulation states that ore is of like kind and grade if it is "economically suitable for use for essentially the same purposes. * * *" The government cites testimony that some purchasers of rough block limestone select individual stones to meet architects' specifications; this fact allegedly makes establishment of a representative price impossible, since the taxpayer might sell individual stones at a higher price than other stones in the same classification could or did command. Thus the government argues that taxpayer's calculation, based on the actual sales of five competitors, must be an overstatement of the price for which it could have sold all its rough block limestone.
Despite this argument, the district court found that the taxpayer could properly rely on the industry-wide grading and pricing system to establish representative prices for the limestone shipped to its mills. We believe the district judge's finding conforms with numerous judicial decisions that a representative market or field price need not be based on comparisons among virtually identical products.
In Alabama By-Products Corp. v. Patterson, 258 F.2d 892 (5th Cir. 1958), cert. denied, 358 U.S. 930, 79 S. Ct. 318, 3 L. Ed. 2d 303 (1959), the taxpayer argued that only "interchangeable" coals were of like kind and grade. Because of the many distinguishing physical and chemical properties of coking coal, no representative price could be established. The court rejected that theory in holding that all Birmingham bituminous coal having coking properties for commercial usage is coal of like kind and grade. "Like kind" is a "broad phrase contemplating the distinction between classes of property," and does not permit differentiation according to the use to which the property is actually put.*fn2 258 F.2d at 898. The court verified the government's establishment of a representative price.
In United States v. Henderson Clay Products, 324 F.2d 7 (5th Cir. 1963), cert. denied, 377 U.S. 917, 84 S. Ct. 1182, 12 L. Ed. 2d 186 (1964), the government argued there was no representative price because taxpayer's clay was not of like kind and grade as clay sold for ceramics because it was mined less selectively. In disagreeing, the court noted that the regulation does not require comparison with "the same" or "identical" products.
In comparable cases involving oil and gas depletion allowances, the Court of Claims has refused to limit comparative markets for the purpose of ascertaining representative prices. A producer selling gas in an intrastate market had to figure its gross income using lower prices at which other producers were selling in interstate markets. Hugoton Production Co. v. United States, 349 F.2d 418, 172 Ct. Cl. 444 (1965). Another producer with wells in the three-state Hugoton Embayment was not allowed to divide the Embayment along state lines to compute a representative market price. The court said that the relevant market need not "further be fragmented by artificial political boundaries due to the presence (and disappearance) of one of the many economic factors at work." Panhandle Eastern Pipe Line Co. v. United States, 408 F.2d 690, 703, 187 Ct. Cl. 129 (1969).
Thus the courts have allowed neither physical characteristics nor end use nor conditions of marketing to narrow the class of products to be used in reaching comparative prices. The district court was correct in finding the existence of a well-established representative market or field price for taxpayer's rough block limestone.
The government urged the district court to apply a 1968 regulation, § 1613-3(c)(6).*fn3 This regulation creates a presumption that a price is not representative if the price plus the cost of all nonmining processes regularly exceeds the actual sales price of the finished product. The theory of the presumption is that an integrated miner-manufacturer which shows year after year of profit from its mining operation and year after year of loss from its manufacturing operation must be overestimating the price of its raw product, and therefore overestimating the expenses of its manufacturing phase. The hypothesis is that no business would continue a milling operation which resulted in actual losses over a number of years.
The district judge found the presumption inapplicable to taxpayer, because Bloomington Limestone's records showed "no pattern of milling losses." Taxpayer submitted two sets of data on this issue: exhibits 16 and 17 chart profits and losses for 1951 through 1968, using taxpayer's list prices to estimate the price of rough block limestone; exhibits 24 and 25 give similar data for 1958 through 1968, but the list prices are reduced by 15 percent.*fn4 The government attorney did not object to the admission of these exhibits, nor did he cross-examine taxpayer's treasurer about their contents. The government now protests that nothing in the record supports taxpayer's use of 15 percent as the adjustment rate for 1960-1968 prices, but we think it was reasonable for the district court to accept the unchallenged estimates to determine whether a pattern of milling losses existed.
Exhibits 16 and 17 show mining profits for each of the 18 years and manufacturing profits for only six of those years. Exhibits 24 and 25, using the representative price adjustment, show mining profits for eight of the 11 years and manufacturing profits for six. Taxpayer's president testified that the manufacturing losses in 1958 and 1959 were caused by depressed market conditions which improved after 1963. He said Bloomington Limestone closed one mill and cut down operations in others in 1958 and 1959, but continued operating the mills at a loss in the hope that the market would change.
We believe this evidence is sufficient to support the finding that manufacturing losses were not regular enough to activate the presumption of § 1.613-3(c)(6).
The government cites three cases where courts have adjusted or rejected a representative market or field price because it did not accurately reflect the economics of taxpayer's business. In Henderson Clay Products v. United States, 377 F.2d 349 (5th Cir. 1967), the proposed representative price included expenditures made by companies selling clay in the ceramics market. Taxpayer did not compete in that market and made no similar expenditures for advertising, management, and research. In the second case, the proposed representative price for Howell Field gas sold near the wellhead had to be reduced by transportation and delivery costs reflected in the comparative market prices. Panhandle Eastern Pipe Line Co. ...