United States v. Skelly Oil Co.

Mr. Justice Marshall

delivered the opinion of the Court.

During its tax year ending December 31,1958, respondent refunded $505,536.54 to two of its customers for overcharges during the six preceding years. Respondent, an Oklahoma producer of natural gas, had set its prices during the earlier years in accordance with a minimum price order of the Oklahoma Corporation Commission. After that order was vacated as a result of a decision of this Court, Michigan Wisconsin Pipe Line Co. v. Corporation Comm’n of Oklahoma, 355 U. S. 425 (1958), respondent found it necessary to settle a number of claims filed by its customers; the repayments in question represent settlements of two of those claims. Since respondent had claimed an unrestricted right to its sales receipts during the years 1952 through 1957, it had included the $505,536.54 in its gross income in those years. The amount was also included in respondent’s “gross income from the property” as defined in § 613 of the Internal Revenue Code of 1954, the section which allows taxpayers to deduct a fixed percentage of certain receipts to compensate for the depletion of natural resources from which they derive income. Allowable percentage depletion for receipts from oil and gas wells is fixed at 27%% of the “gross income from the property.” Since respondent claimed and the Commissioner allowed percentage depletion deductions during these years, 27%% of the receipts in question was added to the depletion allowances to which respondent would otherwise have been entitled. Accordingly, the actual increase in respondent’s taxable income attributable to the receipts in question was not $505,536.64, but only $366,513.99. Yet, when respondent made its refunds in 1958, it attempted to deduct the full $505,536.54. The Commissioner objected and assessed a deficiency. Respondent paid and, after its claim for a refund had been disallowed, began the present suit. The Government won in the District Court, 255 F. Supp. 228 (D. C. N. D. Okla. 1966), but the Court of Appeals for the Tenth Circuit reversed, 392 F. 2d 128 (1968). Upon petition by the Government, we granted certiorari, 393 U. S. 820 (1968), to consider whether the Court of Appeals decision had allowed respondent “the practical equivalent of double deduction,” Charles Ilfeld Co. v. Hernandez, 292 U. S. 62, 68 (1934), in conflict with past decisions of this Court and sound principles of tax law. We reverse.

I.

The present problem is an outgrowth of the so-called “claim-of-right” doctrine. Mr. Justice Brandeis, speaking for a unanimous Court in North American Oil Consolidated v. Burnet, 286 U. S. 417, 424 (1932), gave that doctrine its classic formulation. “If a taxpayer receives earnings under a claim of right and without restriction as to its disposition, he has received income which he is required to return, even though it may still be claimed that he is not entitled to retain the money, and even though he may still be adjudged liable to restore its equivalent.” Should it later appear that the taxpayer was not entitled to keep the money, Mr. Justice Brandéis explained, he would be entitled to a deduction in the year of repayment; the taxes due for the year of receipt would not be affected. This approach was dictated by Congress’ adoption of an annual accounting system as an integral part of the tax code. See Burnet v. Sanford & Brooks Co., 282 U. S. 359, 365-366 (1931). Of course, the tax benefit from the deduction in the year of repayment might differ from the increase in taxes attributable to the receipt; for example, tax rates might have changed, or the taxpayer might be in a different tax “bracket.” See Healy v. Commissioner, 345 U. S. 278, 284-285 (1953). But as the doctrine was originally formulated, these discrepancies were accepted as an unavoidable consequence of the annual accounting system.

Section 1341 of the 1954 Code was enacted to alleviate some of the inequities which Congress felt existed in this area.¹ See H. R. Rep. No. 1337, 83d Cong., 2d Sess., 86-87 (1954); S. Rep. No. 1622, 83d Cong., 2d Sess., 118-119 (1954). As an alternative to the deduction in the year of repayment² which prior law allowed, §1341 (a)(5) permits certain taxpayers to recompute their taxes for the year of receipt. Whenever § 1341 (a)(5) applies, taxes for the current year are to be reduced by the amount taxes were increased in the year or years of receipt because the disputed items were included in gross income. Nevertheless, it is clear that Congress did not intend to tamper with the underlying claim-of-right doctrine; it only provided an alternative for certain cases in which the new approach favored the taxpayer. When the new approach was not advantageous to the taxpayer, the old law was to apply under § 1341 (a)(4).

In this case, the parties have stipulated that § 1341 (a) (5) does not apply. Accordingly, as the courts below recognized, respondent’s taxes must be computed under § 1341 (a) (4) and thus, in effect, without regard to the special relief Congress provided through the enactment of § 1341. Nevertheless, respondent argues, and the Court of Appeals seems to have held, that the language used in § 1341 requires that respondent be allowed a deduction for the full amount it refunded to its customers. We think the section has no such significance.

In describing the situations in which the section applies, § 1341 (a)(2) talks of cases in which “a deduction is allowable for the taxable year because it was established after the close of [the year or years of receipt] that the taxpayer did not have an unrestricted right to such item . . . The “item” referred to is first mentioned in § 1341 (a)(1); it is the item included in gross income in the year of receipt. The section does not imply in any way that the “deduction” and the “item” must necessarily be equal in amount. In fact, the use of the words “a deduction” and the placement of § 1341 in subchapter Q — the subchapter dealing largely with side effects of the annual accounting system — make it clear that it is necessary to refer to other portions of the Code to discover how much of a deduction is allowable. The regulations promulgated under the section make the necessity for such a cross-reference clear. Treas. Reg. on Income Tax (1954 Code) § 1.1341-1 (26 CFR § 1.1341-1). Therefore, when § 1341 (a) (4) — the subsection applicable here — speaks of “the tax . . . computed with such deduction,” it is referring to the deduction mentioned in § 1341 (a) (2); and that deduction must be determined, not by any mechanical equation with the “item” originally included in gross income, but by reference to the applicable sections of the Code and the case law developed under those sections.

II.

There is some dispute between the parties about whether the refunds in question are deductible as losses under § 165 of the 1954 Code or as business expenses under § 162.³ Although in some situations the distinction may have relevance, cf. Equitable Life Ins. Co. of Iowa v. United States, 340 F. 2d 9 (C. A. 8th Cir. 1965), we do not think it makes any difference here. In either case, the Code should not be interpreted to allow respondent “the practical equivalent of double deduction,” Charles Ilfeld Co. v. Hernandez, 292 U. S. 62, 68 (1934), absent a clear declaration of intent by Congress. See United States v. Ludey, 274 U. S. 295 (1927). Accordingly, to avoid that result in this case, the deduction allowable in the year of repayment must be reduced by the percentage depletion allowance which respondent claimed and the Commissioner allowed in the years of receipt as a result of the inclusion of the later-refunded items in respondent’s “gross income from the property” in those years. Any other approach would allow respondent a total of $1.27% in deductions for every $1 refunded to its customers.

Under the annual accounting system dictated by the Code, each year’s tax must be definitively calculable at the end of the tax year. “It is the essence of any system of taxation that it should produce revenue ascertainable, and payable to the government, at regular intervals.” Burnet v. Sanford & Brooks Co., supra, at 365. In cases arising under the claim-of-right doctrine, this emphasis on the annual accounting period normally requires that the tax consequences of a receipt should not determine the size of the deduction allowable in the year of repayment. There is no requirement that the deduction save the taxpayer the exact amount of taxes he paid because of the inclusion of the item in income for a prior year. See Healy v. Commissioner, supra.

Nevertheless, the annual accounting concept does not require us to close our eyes to what happened in prior years. For instance, it is well settled that the prior year may be examined to determine whether the repayment gives rise to a regular loss or a capital loss. Arrow-smith v. Commissioner, 344 U. S. 6 (1952). The rationale for the Arrowsmith rule is easy to see; if money was taxed at a special lower rate when received, the taxpayer would be accorded an unfair tax windfall if repayments were generally deductible from receipts taxable at the higher rate applicable to ordinary income. The Court in Arrowsmith was unwilling to infer that Congress intended such a result.

This case is really no different.⁴ In essence, oil and gas producers are taxed on only 72%% of their “gross income from the property” whenever they claim percentage depletion. The remainder of their oil and gas receipts is in reality tax exempt. We cannot believe that Congress intended to give taxpayers a deduction for refunding money that was not taxed when received. Cf. O’Meara v. Commissioner, 8 T. C. 622, 634—635 (1947). Accordingly, Arrowsmith teaches that the full amount of the repayment cannot, in the circumstances of this case, be allowed as a deduction.

This result does no violence to the annual accounting system. Here, as in Arrowsmith, the earlier returns are not being reopened. And no attempt is being made to require the tax savings from the deduction to equal the tax consequences of the receipts in prior years.⁵ In addition, the approach here adopted will affect only a few cases. The percentage depletion allowance is quite unusual; unlike most other deductions provided by the Code, it allows a fixed portion of gross income to go untaxed. As a result, the depletion allowance increases in years when disputed amounts are received under claim of right; there is no corresponding decrease in the allowance because of later deductions for repayments.⁶ Therefore, if a deduction for 100% of the repayments were allowed, every time money is received and later repaid the taxpayer would make a profit equivalent to the taxes on 27%% of the amount refunded. In other situations when the taxes on a receipt do not equal the tax benefits of a repayment, either the taxpayer or the Government may, depending on circumstances, be the beneficiary. Here, the taxpayer always wins and the Government always loses. We cannot believe that Congress would have intended such an inequitable result.

The parties have stipulated that respondent is entitled to a judgment for $20,932.64 plus statutory interest for claims unrelated to the matter in controversy here; the District Court entered a judgment for that amount. Accordingly, the judgment of the Court of Appeals is reversed and the case is remanded to that court with instructions that it be returned to the District Court for re-entry of the original District Court judgment.

Reversed and remanded.

1 Section 1341 (a) provides:

“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 under this chapter (or the corresponding provisions of prior revenue laws) for the prior taxable year (or years) which would result solely from the exclusion of such item (or portion thereof) from gross income for such prior taxable year (or years).

“For purposes of paragraph (5)(B), the corresponding provisions of the Internal Revenue Code of 1939 shall be chapter 1 of such code (other than subchapter E, relating to self-employment income) and subchapter E of chapter 2 of such code.”

Section 1341 (b) (2) contains an exclusion covering certain eases involving sales of stock in trade or inventory. However, because of special treatment given refunds made by regulated public utilities, both parties agree that § 1341 (b) (2) is inapplicable to this case and that, accordingly, § 1341 (a) applies.

2 In the case of an accrual-basis taxpayer, the legislative history makes it clear that the deduction is allowable at the proper time for accrual. H. R. Rep. No. 1337, 83d Cong., 2d Sess., a294 (1954); S. Rep. No. 1622, 83d Cong., 2d Sess., 451-452 (1954).

3 The Commissioner has long recognized that a deduction under some section is allowable. G. C. M. 16730, XV-1 Cum. Bull. 179 (1936).

4 The analogy would be even more striking if in Arrowsmith the individual taxpayers had not utilized the alternative tax for capital gains, as they were permitted to do by what is now § 1201 of the 1954 Code. Where the 25% alternative tax is not used, individual taxpayers are taxed at ordinary rates on 50% of their capital gains. See § 1202. In such a situation, the rule of the Arrowsmith case prevents taxpayers from deducting 100% of an item refunded when they were taxed on only 50% of it when it was received. Although Arrowsmith prevents this inequitable result by treating the repayment as a capital loss, rather than by disallowing 50% of the deduction, the policy behind the decision is applicable in this case. Here it would be inequitable to allow a 100% deduction when only 72%% was taxed on receipt.

5 Compare the analogous approach utilized under the “tax benefit” rule. Alice Phelan Sullivan Corp. v. United States, 180 Ct. Cl. 659, 381 F. 2d 399 (1967); see Internal Revenue Code of 1954 § 111. In keeping with the analogy, the Commissioner has indicated that the Government will only seek to reduce the deduction in the year of repayment to the extent that the depletion allowance attributable to the receipt directly or indirectly reduced taxable income. Proposed Treas. Reg. § 1.613-2 (e)(8), 33 Fed. Reg. 10702-10703 (1968).

6 The 10% standard deduction mentioned in Mr. Justice Stewart's dissent, post, at 697, differs in that it allows as a deduction a percentage of adjusted gross income, rather than of gross income. See § 141 ; cf. §§ 170, 213. As a result, repayments may in certain cases cause a decrease in the 10% standard deduction allowable in the year of repayment, assuming that the repayment is of the character to be deducted in calculating adjusted gross income. See § 62.