Skelly Oil Company v. United States ( 1968 )

SETH, Circuit Judge.

The appellant brought this action for refund of income taxes on the ground that it was entitled in full to a deduction under Section 1341(a) (4) of the Internal Revenue Code of 1954, for refunds to corporations which purchased gas from it made following a price reduction.

The trial court reduced the claimed deduction by the amount of the percentage depletion deduction, and the taxpayer has taken this appeal.

The appellant has been in the business of producing and selling natural gas in Oklahoma for many years, and was so engaged during the period when a state minimum price order for natural gas sales at the wellhead was put into effect. This order raised the price of the gas appellant was selling under preexisting contracts, and continued in effect until it was declared invalid in Michigan Wisconsin Pipe Line Co. v. Corporation Commission of State of Oklahoma, 355 U.S. 425, 78 S.C. 409, 2 L.Ed.2d 412. After the order was terminated, a purchaser of gas from appellant during the period the order was in effect brought a suit to recover from Skelly the difference between the contract rate and the price order rate. This suit was settled by the repayment by appellant to the purchaser of the sum of $500,000.00. Appellant paid another purchaser in a similar position the sum of $5,536.54.

The total of these two amounts was claimed and entered in its return as a deduction in 1958, the year it was paid. This was done pursuant to Section 1341 (a) (4) of the Code of 1954 in that it was established after the close of the prior taxable years that the taxpayer did not have an “unrestricted right” to such “an item” which was included in its gross income because it appeared it had such right for several prior taxable years, 1952 through 1957.

As indicated above, appellant claimed it was entitled to deduct the entire amount of the refunds. The trial court did not allow this amount, but instead reduced it by 27% per cent which was the percentage appellant had deducted in its returns for the years 1952-57 from its gas sales as depletion.

The statute (Section 1341 of the Internal Revenue Code of 1954) provides in part that:

“(a) General rule — If—

“(1) an item was included in gross income for a prior taxable year (or years) because it appeared that the taxpayer had an unrestricted right to such item;

“(2) a deduction is allowable for the taxable year because it was established after the close of such prior taxable year (or years) that the taxpayer did not have an unrestricted right to such item or to a portion of such item; and

“(3) the amount of such deduction exceeds $3,000,

“then the tax imposed by this chapter for the taxable year shall be the lesser of the following:

“(4) the tax for the taxable year computed with such deduction; or

“(5) an amount equal to—

“(A) the tax for the taxable year computed without such deduction, minus

“(B) the decrease in tax * * * for the prior taxable year * * * which would result solely from the exclusion of such item * * * from gross income for such prior taxable year * *

The parties stipulated in the trial court that appellant’s taxes for the year 1958 are to be computed under the above subsection (a) (4).

As to the ground rules, it is apparent that the burden was on the appellant under these circumstances to establish a deduction. Corn Products Refining Co. v. Commissioner of Internal Revenue, 350 U.S. 46, 76 S.Ct. 20, 100 L.Ed. 29. Further as a general proposition a narrow construction is placed on statutory provisions for deductions. United States v. Olympic Radio & Television, Inc., 349 U.S. 232, 75 S.Ct. 733, 99 L.Ed. 1024. The rules as to construction generally are contained in United States v. Allen, 293 F.2d 916 (10th Cir.), and in United States v. American Trucking Ass’ns, Inc., 310 U.S. 534, 60 S.Ct. 1059, 84 L.Ed. 1345.

The taxpayer argues on this appeal that the express wording of the section should be applied, and there are involved at least two separate and distinct tax events each fitting nicely into the statutory language. It also urges that the deduction dollars were without question paid out, and cannot be or should not be traced to their origin in a prior year.

On the other hand the Government argues that Congress could not have intended that such a benefit accrue to the taxpayer, that the several events are related, and one should be used to define the other.

The trial court concluded that the section was not clear, and resort should be had to its legislative history. Also it concluded that the policy of the legislation would not permit the result sought by the taxpayer, it being an unreasonable one. The court concluded that: “Congress intended that a taxpayer should get at least equal tax benefit but cannot have intended that a taxpayer should get a deduction allowable for income on which he had not previously paid a tax because of some benefit accruing to the specific income such as a depletion allowance. National and O’Meara, supra [National Life & Accident Insurance Company v. United States, D.C., 244 F.Supp. 135; O’Meara v. Commissioner of Internal Revenue, 8 C.C. 622].”

When the facts in the case at bar are set against the bare wording of the statute it appears that the requirements are satisfied to permit a deduction in the full amount. The “item” here considered was included in the “gross income” of the taxpayer during the several years prior to 1958, and it appeared that it had the unrestricted right thereto. Further “a deduction is allowable for the taxable year [1958]” because the facts show that after 1957 the taxpayer did not have the unrestricted right to “a portion of such item,” and the amount of the deduction is greater than $3,000.00. Thus the tax for 1958 would be computed with “such deduction.” It is apparent that the term “gross income,” “exclusion,” and “deduction” used in the statute have well defined meanings. The parties stipulated that the $505,536.54 had all been included in the taxpayer’s “gross income” for the years 1952-57. Thus if the wording is applied without more, the appellant is entitled to the entire deduction.

Before Section 1341 was enacted, a taxpayer in appellant’s position was permitted to deduct the amount of the item restored in the year it was so returned. The “claim of right” doctrine was firmly established by North American Oil Consolidated v. Burnet, 286 U.S. 417, 52 S.Ct. 613, 76 L.Ed. 1197. There was no alternative, however, if any remedy was sought as was held in both United States v. Lewis, 340 U.S. 590, 71 S.Ct. 522, 95 L.Ed. 560, and in Healy v. Commissioner of Internal Revenue, 345 U.S. 278, 73 S.Ct. 671, 97 L.Ed. 1007. There thus existed the possibility that the taxpayer would be benefitted by the deduction over the treatment he would otherwise have received, or that he would be prejudiced. The result was then determined by a number of factors in the tax computation for the two or more years including the most obvious one — a change in tax rates. Thus the taxpayer in the pre-Section 1341 period was at the mercy of the circumstances with no choice given to him. The above cited cases establishing and refining the “claim of right” rule also reiterated the annual accounting doctrine and asserted it must be applied despite inequities which might arise from it.

For the present consideration it is sufficient to note that before Section 1341 a taxpayer by virtue of the permitted deduction could receive more benefit than the tax originally paid by him upon the “item” which had to be restored. Thus a benefit in the current year was recognized as a possibility, but not limited or related to the tax paid on the item in the previous year. It was then treated as any other deduction for these purposes in the year of restoration.

The change in “law” by the statutory enactment of Section 1341, considering the wording alone, was by the addition of the provision in subsection (a) (5) directed to those taxpayers who would suffer a disadvantage by the use of a current year deduction. This prejudice was removed by permitting the re-computation of taxes for the current year without the deduction and then a reduction of the tax so computed by the amount of tax attributable to the use of the restored amount in the earlier year if such a route would result in a lesser tax than would a current year deduction. The alternative recomputation provision appears in subsection (a) (5), and the current year deduction is recognized in (a) (4), as it existed before in a non-statutory form. It must be assumed that Congress had a real purpose in enacting the new remedy in (a) (5), and that it was to afford some needed relief in giving the taxpayer an alternative. There is nothing in the enactment itself to indicate an attempt to change the current year deduction remedy.

Thus it appears that Congress by Section 1341 enacted the existing rule as to current year deductions, and added another and new provision whereby the taxpayer who qualifies can always receive a tax benefit from the deduction at least equal to the tax on the item when added to income, “and may receive a tax benefit of a greater amount.” 2 Mertens, Law of Federal Income Taxation 340, ch. 12, § 12.106a (Zimet & Stanley Rev.). Thus it must be concluded that Congress sought to make no change in the current year deduction remedy, but only added the recomputation provision. The statutory enactment may have been precipitated by the strict application of the annual accounting rule in cases such as Healy v. Commissioner of Internal Revenue, 345 U.S. 278, 73 S.Ct. 671, 97 L.Ed. 1007, 14 Oil & Gas Tax Quarterly 70.

The trial court found that the section was unclear or ambiguous, and resorted to the legislative history of the enactment of Section 1341. We do not decide whether or not the resort to the history was proper, or whether the wording is without such ambiguity. The legislative history leads to the same conclusion as does the examination of the preexisting state of the law and the statutory language described above.

The cases permit the examination of transactions taking place in prior years to identify or to characterize transactions in the current year. Arrowsmith v. Commissioner of Internal Revenue, 344 U.S. 6, 73 S.Ct. 71, 97 L.Ed. 6 (a pre-Section 1341 case), is an example. This may be done without violating the annual accounting principle, and a form of it appears in subsection (a) (5); however, we see no reason in the Act to reexamine the prior years’ transactions in the case before us. The statute in subsection (a) (4), with which we are here concerned, does not require or indicate in any way that this be done.

The Government places great reliance on O’Meara v. Commissioner of Internal Revenue, 8 T.C. 622, 1947. There the taxpayer reported as income certain royalties received from oil production. He was later found by a court not to have title to the lease or land and had to repay the amounts received. This factor is an obvious distinction from the case at bar. There the question became whether the taxpayer was entitled to any deduction at all in the current year. See also Parr v. Scofield, 185 F.2d 535 (5th Cir.). The Tax Court in O’Meara held the taxpayer was entitled to a deduction in the current year of the amount repaid less the depletion allowance. The point with which we are here concerned is not developed in the opinion as the court does not indicate how the deduction for depletion should be applied. In any event the subsequent enactment of Section 1341 without stating any conditions or adjustments makes the cited case of doubtful authority.

To apply the rule sought by the Government would require the imposition of a limitation on the use of Section 1341 (a) (4) determined by the amount of taxes paid by appellant in the prior years. There was no limitation or adjustment required in the doctrine expressed in (a) (4) before its enactment, and none is indicated in the statute. There appears to be no relationship established by Congress between (a) (4) and the prior year’s computation other than those expressed in the Act, none of which are here pertinent. The Section only requires the tax for the current year to be figured “with such deduction.”

There is no authority to permit a readjustment of the depletion allowance of the prior years nor may later happenings alter it. Hugoton Production Co. v. United States, 349 F.2d 418, 172 Ct.Cl. 444.

Further there is no indication that the source of the dollars used in the repayment was to be considered before Section 1341(a) (4) nor thereafter, any more than the source of the dollars used for other deductions.

Much could be written on the subject of general policy about the result of this application of the statute without a judicial addition of conditions. This is however a specific, narrow statutory provision for a particular set of circumstances, and no broad general policy of Congress is indicated. The words used in the section have a clearly recognized meaning in the tax field, and the whole section is consistent when applied as its words direct. The refund problem and depletion was well recognized at the time of the statutory enactment.

The benefit which may accrue to the appellant is large, and thus it is different from previous instances where the benefit was small although well recognized ; however, we see no reason to make a distinction based on the amount of money involved to override the statutory provisions. The trial court made no such distinction, but instead indicated that the general principles and the O’Meara case led to an addition of requirements not expressed in the statute. We cannot agree with this either, as the mandate of Congress is clear.

Reversed.