Mitsubishi Cement Corporation & Subsidiaries, A Delaware Corporation v. Commissioner

T.C. Memo. 2018-152UNITED STATES TAX COURT
MITSUBISHI CEMENT CORPORATION & SUBSIDIARIES, A DELAWARE
CORPORATION, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent*
Docket No. 7161-16. Filed September 13, 2018.
Paul W. Jones, for petitioner.
Michael W. Tan and Aely K. Ullrich, for respondent.
SUPPLEMENTAL MEMORANDUM FINDINGS OF FACT AND OPINION
COHEN, Judge: In our prior opinion in this case, Mitsubishi Cement Corp.
& Subs. v. Commissioner (Mitsubishi I), T.C. Memo. 2017-160, we decided two
*
This opinion supplements our previously filed opinion Mitsubishi Cement
Corp. & Subs. v. Commissioner, T.C. Memo. 2017-160.
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[*2] issues regarding the determination of petitioner’s allowable depletion
deductions for 2011 and 2012. We held that petitioner must apply a percentage
depletion rate of 14% and that it may not include the costs of certain purchased
minerals as mining costs in calculating gross income from mining under the
proportionate profits method, as provided in section 1.613-4(d)(4), Income Tax
Regs. After we issued Mitsubishi I, trial was held to decide the remaining issue,
which is the correct determination of petitioner’s gross sales for the purpose of the
proportionate profits method. Unless otherwise indicated, all section references
are to the Internal Revenue Code in effect for the years in issue, and all Rule
references are to the Tax Court Rules of Practice and Procedure.
FINDINGS OF FACT
The background facts on which we relied in Mitsubishi I were fully
stipulated. Those facts are for the most part relevant to the issue we address in this
opinion, and we incorporate certain of them verbatim from Mitsubishi I. The
parties filed a supplemental stipulation of facts, and the additional stipulated facts
are incorporated in our findings by this reference. We also find facts based upon
the evidence presented at trial.
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[*3] Petitioner’s principal place of business was Nevada when it filed the
petition. Its largest shareholder is Mitsubishi Materials Corp. (MMC) in Japan.
MMC owns 67% of petitioner.
Petitioner’s primary business activity is the production of finished cement at
its Cushenberry Cement Plant (Cushenberry) near Victorville, California.
Petitioner mines calcium carbonates at Cushenberry, and it purchases other
minerals from third parties. It mixes the mined calcium carbonates with the
purchased minerals to produce finished cement. Generally petitioner sells the
cement to customers that combine it with gravel, sand, and water to produce
ready-mix concrete. The market in which it sells cement includes the southern tip
of Nevada and southern California, with the largest portion of its sales occurring
in or around Los Angeles, California.
Petitioner produces only Portland cement. It produces several types of
Portland cement, each of which has a different chemical composition and may be
used for a different purpose. Specifically, petitioner produces and sells Type II/V
cement, Type III “light” cement, block cement, plastic cement, and premium oil
well cement. Each type of cement that petitioner sells to customers is certified to
meet industry standards set by the American Society for Testing and Materials
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[*4] (ASTM). Cement producers use ASTM standards to certify that their
products meet the grade and quality specifications for specific types of cement.
During the years in issue most of petitioner’s sales were to the subsidiaries
of MCC Development Corp. (MCCD). MMC owns 70% of MCCD, and
petitioner’s president, Kimball McCloud, is also president of MCCD. MCCD
owns 100% of each of three subsidiaries: Robertson’s Ready Mix (Robertson’s
R/M), Nevada Ready Mix (Nevada R/M), and Service Rock Products (Service
Rock) (collectively, MCCD subsidiaries). During the years in issue MCCD also
owned a 30% interest in Superior Ready Mix (Superior). In addition to its sales to
MCCD subsidiaries, petitioner made sales to Superior, and it made sales to a
number of purchasers in which MCCD held no interest (collectively, with
Superior, noncontrolled purchasers).
During the years in issue petitioner sold Type II/V cement and Type III
cement to MCCD subsidiaries. It did not sell plastic, block, or premium oil well
cement to MCCD subsidiaries. The following table reflects petitioner’s actual
gross sales for 2011.
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[*5] Type II/V cement
Purchaser Tons Price Price per ton
Robertson’s R/M 960,581 $51,871,371 $54.00
Nevada R/M 26,897 1,828,993 68.00
Service Rock 35,364 2,404,759 68.00
Noncontrolled purchasers 225,370 14,738,512 65.40
Total 1,248,212 70,843,635
Type III cement
Purchaser Tons Price Price per ton
Robertson’s R/M 3,710 $356,159 $96.00
Noncontrolled purchasers 41,671 4,018,851 96.44
Totals 45,381 4,375,010
Block cement
Purchaser Tons Price Price per ton
Noncontrolled purchasers 44,630 $3,666,416 $82.15
Totals 44,630 3,666,416
Plastic cement
Purchaser Tons Price Price per ton
Noncontrolled purchasers 4,194 $274,215 $65.38
Totals 4,194 274,215
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[*6] Premium oil well cement
Purchaser Tons Price Price per ton
Noncontrolled purchasers 11,664 $1,166,366 $100.00
Totals 11,664 1,166,366
The following table reflects petitioner’s actual gross sales for 2012.
Type II/V cement
Purchaser Tons Price Price per ton
Robertson’s R/M 1,059,403 $57,207,755 $54.00
Nevada R/M 46,346 2,981,442 64.33
Service Rock 61,739 3,975,128 64.39
Noncontrolled purchasers 245,902 15,625,665 63.54
Totals 1,413,390 79,789,990
Type III cement
Purchaser Tons Price Price per ton
Robertson’s R/M 4,332 $415,878 $96.00
Noncontrolled purchasers 44,771 4,383,377 97.91
Totals 49,103 4,799,255
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[*7] Block cement
Purchaser Tons Price Price per ton
Noncontrolled purchasers 47,039 $3,949,581 $83.96
Totals 47,039 3,949,581
Plastic cement
Purchaser Tons Price Price per ton
Noncontrolled purchasers 6,672 $454,878 $68.18
Totals 6,672 454,878
Premium oil well cement
Purchaser Tons Price Price per ton
Noncontrolled purchasers 12,681 $1,268,076 $100.00
Totals 12,681 1,268,076
Petitioner prepares an annual letter that it sends to all of its customers to
notify them of the prices that it intends to charge for cement for that year.
Customers are able to contact petitioner’s sales representatives to negotiate a
lower price for their individual purchases. Generally, petitioner’s prices for sales
vary from customer to customer.
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[*8] MCCD subsidiaries receive petitioner’s annual pricing letters, and their
managers may contact petitioner if they believe that the prices set are too high.
However, McCloud controls the final decision regarding the prices that MCCD
subsidiaries pay for their purchases.
On petitioner’s income tax returns for the years in issue it claimed
deductions for depletion pursuant to section 611 in connection with its mining of
calcium carbonates. It determined its depletion deductions using percentage
depletion described in section 613 and the regulations thereunder. For purposes of
percentage depletion, petitioner calculated its gross income from mining using the
proportionate profits method. For both years in issue petitioner applied the
proportionate profits method using its actual gross sales of finished cement, which
were $80,325,643 for 2011 and $90,261,779 for 2012.
OPINION
I. Percentage Depletion and Proportionate Profits Method
Section 611 provides that there shall be allowed as a deduction “a
reasonable allowance for depletion”. Generally the deduction is calculated as a
percentage of “the gross income from the property”. Sec. 613(a). “Gross income
from the property” in petitioner’s case means “gross income from mining”. Sec.
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[*9] 613(c)(1). The amount of the depletion deduction under section 613(a) can
be expressed by the following formula:
Gross Income From Mining × Percentage Depletion Rate =
Depletion Deduction
Section 613(b) provides the percentage depletion rates for specific classes
of minerals. The statutory percentage depletion rate for calcium carbonates is
14%. Sec. 613(b)(7); see Mitsubishi I, at *8-*9. The other component of
percentage depletion, gross income from mining, is determined according to the
regulations. See sec. 1.613-4, Income Tax Regs.
A taxpayer who conducts both mining and nonmining activities with respect
to a given mineral (as in the manufacture of finished products) must make an
allocation between gross income from the mining activity and gross income from
the nonmining activity. The percentage depletion rate is applied only to the gross
income from mining. Id. para. (a); see United States v. Cannelton Sewer Pipe Co.,
364 U.S. 76, 86-87 (1960). Under the general rule that applies in such a case,
gross income from the mining activity is computed on the basis of a representative
market or field price for the mineral being processed. Sec. 1.613-4(c), Income Tax
Regs. Where a representative market or field price for a particular mineral cannot
be ascertained, the proportionate profits method of computing gross income from
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[*10] mining shall be used unless permission to use an alternative method of
computation is obtained from the Commissioner. Id. para. (d); see Commissioner
v. Portland Cement of Utah, 450 U.S. 156, 160-161 (1981).
“The objective of the ‘proportionate profits’ method of computation is to
ascertain gross income from mining by applying the principle that each dollar of
the total costs paid or incurred to produce, sell, and transport the first marketable
product * * * earns the same percentage of profit.” Sec. 1.613-4(d)(4), Income
Tax Regs. Under the proportionate profits method, a fraction, which is the ratio of
the taxpayer’s mining costs to its total mining and nonmining costs, is applied to
the taxpayer’s gross sales of the first marketable product, and the product
therefrom is treated as the taxpayer’s gross income from mining. Sec. 1.613-
4(d)(4)(ii), Income Tax Regs. The regulations provide the following formula:
[Mining Costs/Total Costs] × Gross Sales = Gross Income From Mining
Id.Petitioner’s first marketable product is finished cement. In Mitsubishi I we
considered which of petitioner’s costs for the production of cement could be
treated as mining costs for the purpose of applying the proportionate profits
formula. The issue that we consider in this opinion is the correct determination of
petitioner’s gross sales.
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[*11] II. Determination of Gross Sales
A. Section 1.613-4(d)(4)(v), Income Tax Regs.
Section 1.613-4(d)(4)(v), Income Tax Regs., provides the following in
relevant part with respect to the determination of a taxpayer’s gross sales under the
proportionate profits method:
(a) * * * [T]he term “gross sales (actual or constructive)”
means the total of the taxpayer’s actual competitive sales to others of
the first marketable product or group of products, plus the taxpayer’s
constructive sales of the first marketable product or group of products
used or retained for use in his own subsequent operations, subject to
the adjustments required by paragraph (e) of this section. See (b) of
this subdivision in the case of actual sales between members of
controlled groups and in the case of constructive sales. * * *
(b) * * * In the case of * * * sales between members of a
controlled group, and in the case of constructive sales, the prices for
such sales shall be determined by use of the principles set forth in
paragraph (c) of this section, subject to the adjustments required by
paragraph (e) of this section. * * * [Emphasis added.]
The parties agree that petitioner and the MCCD subsidiaries are members of a
“controlled group” as that term is used in the regulations. See sec. 1.613-4(j),
Income Tax Regs. (definition of controlled group). Therefore, the prices for sales
between them should be determined “by use of the principles set forth in” section
1.613-4(c), Income Tax Regs., for determining the representative market or field
prices for depletable minerals. Generally, the representative market or field price
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[*12] is “the dollar figure or amount which most nearly represents the approximate
price at which the taxpayer, in light of market conditions, could have sold * * *
[the mineral or finished product at issue]”. Sec. 1.613-4(c)(1), Income Tax Regs.
B. Representative Market Prices
Generally the regulations direct that a miner-manufacturer such as petitioner
determine gross sales used in the proportionate profits method by treating its sales
of first marketable product to fellow members of a controlled group as if those
sales were made at a representative market price. Petitioner did not do this for the
years in issue. On its income tax returns it did not attempt to determine market
prices for the types of cement that it sold or to apply such prices to the sales that it
made to MCCD subsidiaries. Instead, for each year petitioner used its actual gross
sales, $80,325,643 for 2011 and $90,261,779 for 2012, in computing gross income
from mining.
Petitioner now contends that it should be allowed to increase gross sales for
the purpose of the proportionate profits method by applying the average prices per
ton that noncontrolled purchasers paid for its finished cement to its sales to
MCCD subsidiaries. On the basis of that proposed application, it contends that we
should determine that its gross sales were $91,116,567 and $100,293,026 for the
years in issue, respectively. An increase in petitioner’s gross sales under the
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[*13] proportionate profits method would increase its gross income from mining
and would, accordingly, increase the amount of its allowable depletion deduction
for each year in issue.
Petitioner failed to apply the regulations in its original tax filings, and now
it contends that we should apply the regulations to redetermine its gross sales and
allow increased deductions. We agree that under the regulations petitioner’s gross
sales to MCCD subsidiaries should have been determined using representative
market prices; specifically, it should have determined and applied market prices
for Type II/V cement and Type III cement, which are the two types that it sold to
MCCD subsidiaries. However, petitioner bears the burden of establishing gross
sales which are greater than those that it first reported and used in computing its
deductions and which respondent accepted when petitioner filed the original
returns.
Statements on tax returns are admissions that must be overcome by cogent
proof. See Estate of Hall v. Commissioner, 92 T.C. 312, 337-338 (1989).
Generally the taxpayer bears the burden of proof with respect to any claimed
deduction, INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992), and this
burden includes establishing the correct amount of the deduction, Clapp v.
Commissioner, 321 F.2d 12, 14 (9th Cir. 1963), aff’g 36 T.C. 905 (1961); see also
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[*14] sec. 6001; sec. 1.6001-1(a), Income Tax Regs. To meet its burden of proof
for the deductions at issue petitioner must prove the representative market prices
for its sales to members of the controlled group.
Petitioner contends that we should adopt the weighted averages of the prices
of its own sales to noncontrolled purchasers during the years in issue as the
representative market prices for Type II/V and Type III cements. The regulations
provide that representative market prices are to be ascertained “on the basis of an
analysis of actual competitive sales by the taxpayer or others”. Sec. 1.613-4(c)(1),
Income Tax Regs. “The taxpayer’s own actual sales * * * shall be taken into
account when establishing market or field prices, provided that those sales are
determined to be representative.” Id.Petitioner offered evidence intending to show that its average prices for
sales to noncontrolled purchasers represented the market prices for the years in
issue. Petitioner’s vice president and corporate controller testified about the extent
of petitioner’s geographical market and the nature of its sales to noncontrolled
purchasers. He testified that petitioner faces many competitors in the southern
California market that sell Type II/V and Type III cements meeting the same
ASTM standards as petitioner’s products. He testified that petitioner’s prices for
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[*15] sales to noncontrolled purchasers are negotiated and that the purchasers are
able to buy cement from other producers.
The testimony of petitioner’s witness indicates that its sales to
noncontrolled purchasers during the years in issue were competitive and
negotiated, as opposed to controlled, transactions. However, to rely on
petitioner’s own sales as a basis for determining market price, we would need to
determine also that those sales were “representative” as compared to sales by other
producers in the relevant market. See id. At trial petitioner provided three
exhibits which report certain aggregated pricing data for cement sales in the
United States for the years in issue: (1) the United States Geological Survey’s
Mineral Yearbook for Cement for each of the years in issue (USGS yearbooks);
(2) excerpts from newsletters published by the Engineering News-Record (ENR
newsletters); and (3) a screenshot from Statista, an online statistics portal (Statista
web page).
Section 1.613-4(c)(3), Income Tax Regs., provides that in the determining a
representative market price for the taxpayer’s ore or mineral, “consideration shall
be given only to prices of ores or minerals of like kind and grade as the taxpayer’s
* * * and with which, under commercially accepted standards, the taxpayer’s ore
or mineral would be considered to be in competition”. An ore or mineral will be
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[*16] considered to be of like kind and grade “if, in common commercial practice,
it is sufficiently similar in chemical, mineralogical, or physical characteristics to
the taxpayer’s ore or mineral that it is used, or is commercially suitable for use, for
essentially the same purposes as the uses to which the taxpayer’s ore or mineral is
put.” Sec. 1.613-4(c)(2), Income Tax Regs. Generally, whether an ore or mineral
is of like kind and grade will be determined “by reference to industrial or
commercial specifications”. Id.Petitioner’s witness testified that each of the different types of Portland
cement has a unique chemical composition and each is suited to a particular job or
use. Each type meets its own set of ASTM standards, which are the industry
standards for cement grade and quality. We conclude on the basis of the evidence
presented that the various types are not interchangeable in commercial practice.
The evidence also shows that the prices charged for the different types vary
considerably.
None of the three exhibits listed above provides information for sales that
are directly comparable to, and would be useful in analyzing the competitive
market for, the sales at issue. The USGS yearbooks provide the averages of the
sale prices for all types of Portland cement sold in California and do not
disaggregate and provide data for sales of Type II/V cement or Type III cement
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[*17] specifically. The ENR newsletters provide the average sale prices for Type I
cement; Type I is a type of Portland cement that petitioner does not sell. The
Statista web page provides the averages of the sale prices for all Portland cements
and masonry cement, which petitioner also does not sell. Like the USGS
yearbooks, the Statista web page provides no data on the sale prices for the
different types of Portland cement. Each of the exhibits analyzes sales data and
incorporates or reports prices for finished products which are not of the “like kind
and grade” of the Type II/V and Type III cements that petitioner sold to
noncontrolled purchasers and MCCD subsidiaries.
At trial petitioner’s counsel acknowledged that the data in the exhibits could
not be used directly to determine a market price for the two types of cement at
issue. He argued that the pricing data is relevant “to show that the price [i.e., the
average of petitioner’s own sales] * * * is representative in a comparative way”.
On brief petitioner contends that “[w]hen compared with the data [in the exhibits]
* * * [petitioner’s prices] are very reasonable”.
We cannot speculate on the reasonableness of petitioner’s proposed market
prices in the light of the limited data provided. We reject the contention that the
information in the exhibits is relevant “in a comparative way” to determining
representative market prices for the sales at issue. Petitioner has the burden of
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[*18] proving those amounts. We are not experts in cement composition and sales
practices, and petitioner has not provided information for us to engage in an
analysis of the market prices for Type II/V cement or Type III cement as compared
to the prices for other cements.
Petitioner failed to establish that its own sales to noncontrolled purchasers
were representative of Type II/V and Type III cement sales in petitioner’s market
for the years in issue. Because we are unable to determine that the sales were
representative, we will not take them into account in determining representative
market prices. See sec. 1.613-4(c)(2), Income Tax Regs. Petitioner has not met its
burden of proving representative market prices for the types of cement that it sold
to MCCD subsidiaries. We agree with respondent that petitioner must use the
gross sales amounts that it originally reported, i.e., its actual gross sales, to
compute gross income from mining under the proportionate profits method.
C. Applicability of Section 1.613-4(e), Income Tax Regs.
Even if we held that petitioner had proven representative market prices for
the cement sales at issue, we conclude that any increases to petitioner’s gross sales
for the purpose of the proportionate profits method would be offset by adjustments
required under the regulations. Section 1.613-4(d)(4)(v), Income Tax Regs.,
provides that in all cases the determination of gross sales is “subject to the
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[*19] adjustments required by paragraph (e) of this section.” Section 1.613-
4(e)(1), Income Tax Regs., provides that “[i]f a taxpayer computes gross income
from mining under the provisions of paragraph (d) * * * discounts actually
allowed (if not otherwise taken into account) shall be subtracted from the gross
sales (actual or constructive), and shall not be considered a cost, of the first
marketable product or group of products.”
Petitioner contends that it does not give discounts to purchasers and that no
adjustments to gross sales for the years in issue would be warranted under section
1.613-4(e), Income Tax Regs. However, the parties’ stipulations establish that one
of the MCCD subsidiaries, Robertson’s R/M, paid average prices per ton for Type
II/V cement that were substantially lower than the average prices that
noncontrolled purchasers paid. Most of petitioner’s gross sales of Type II/V
cement for each of the years in issue were sales to Robertson’s R/M. Robertson’s
R/M also paid less on average for its purchases of Type III cement than did
noncontrolled purchasers.
Regardless of whether petitioner labels the price differences “discounts”,
Robertson’s R/M paid less than the prices that petitioner would have us accept as
the representative market prices. Section 1.613-4(e)(1), Income Tax Regs.,
provides that “[t]he provisions of this subparagraph shall apply to arrangements
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[*20] which have the same effect as trade or cash discounts, regardless of the form
of the arrangements.” Although the arrangement between petitioner and
Robertson’s R/M may not have been structured or regarded by the parties as a
sales discount, the effect was the same. If we adopted petitioner’s proposed
market prices and applied them to the sales to MCCD subsidiaries, the regulations
would require that the recomputed gross sales amounts be reduced to reflect the
actual, below-market prices that Robertson’s R/M paid for its purchases.
III. Conclusion
Petitioner argues that the reason that the regulations require a taxpayer to
use representative market prices to determine gross sales for sales to members of a
controlled group is to prevent the taxpayer from manipulating the prices of
controlled sales and increasing its gross income from mining (and the amount of
its depletion deduction). It argues that respondent’s position in this case, that
petitioner must use its actual gross sales to compute gross income from mining, is
“short-sighted” because in future cases “the petitioner could inflate its ‘actual
sales’ * * * and take a higher depletion deduction than the regulations clearly
intend.” Putting aside that petitioner bears the burden of proof with respect to the
issue of representative market prices (and has failed to meet that burden), its
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[*21] argument ignores the manner in which the regulations serve the regulatory
objective in cases such as this one.
The regulatory requirement that gross sales to members of a controlled
group be reduced to reflect representative market prices prevents the taxpayer
from claiming an inflated amount of gross income from mining. Simultaneously,
the regulations do not allow the taxpayer to increase gross sales by relying on
representative market prices where, as here, it has chosen to give members of the
controlled group substantial discounts on its finished products. In either
circumstance the regulations operate to prevent the taxpayer from artificially
increasing gross sales and the amount of the depletion deduction. Gross sales for
the purpose of the proportionate profits method may be adjusted downwards under
the regulations, but they may never be adjusted upwards. This result comports
with the purpose of the regulations as petitioner interprets it.
Petitioner did not establish representative market prices for its sales to
MCCD subsidiaries, and even if it had, we conclude that under applicable
regulations petitioner would have been required to reduce gross sales for purposes
of calculating gross income from mining to reflect the discounted prices paid for a
substantial portion of those sales. In any event, petitioner’s gross sales under the
proportionate profits method should not be increased.
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[*22] Petitioner has not shown that it is entitled to greater depletion deductions
than those that respondent would allow on the basis of the stipulations and our
holdings in Mitsubishi I. To allow for computations to be submitted in the light of
our holdings herein and in the prior opinion,
Decision will be entered
under Rule 155.