Paragon Jewel Coal Company v. Commissioner of Internal Revenue/Dissent Goldberg

by Arthur Goldberg

United States Supreme Court

380 U.S. 624

Paragon Jewel Coal Company  v.  Commissioner of Internal Revenue

 Argued: March 8, 1965. --- Decided: April 28, 1965

Mr. Justice GOLDBERG, with whom Mr. Justice BLACK joins, dissenting.

I respectfully dissent. I cannot accept the Court's formalistic view of the depletion provisions of the Internal Revenue Code of 1954, §§ 611, 613, and 614, which, as applied to this case, would give the entire depletion allowance to Paragon, the lessee of the coal-bearing land. I cannot agree with the Court's decision that a lessee of mineral lands, whose total investment may consist merely of a promise to pay a small royalty for minerals produced, is entitled to the full allowance for depletion and that no share of this allowance is to be apportioned to a mining company with substantial investment in digging and maintaining a particular coal mine. I believe that the issue in this case is basically a simple one: For purposes of the depletion allowance under the Internal Revenue Code, should the mine operators here be viewed as independent contractors selling their services to Paragon, the lessee, or should they be viewed as entrepreneurs participating in a type of joint venture to which Paragon contributes its lease of the land and certain necessary equipment and for which the mine operators provide the other investment necessary to open and run the mines? A look through the formal legal arrangements to the underlying economic realities makes clear that the position of the miners is far closer to that of the entrepreneur participating in a joint venture than to that of a seller or services. For this reason I would hold that the miners have 'an economic interest in the * * * (mineral), in place, which is depleted by production,' Palmer v. Bender, 287 U.S. 551, 557, 53 S.Ct. 225, 227, 77 L.Ed. 489, and they are therefore entitled to a fairly proportioned share of the depletion allowance.

The factual situation presented by this case is far different from that considered by the Court in Parsons v. Smith, 359 U.S. 215, 79 S.Ct. 656, 3 L.Ed.2d 747. Parsons held that persons contracting with the owners of coal-bearing land to strip-mine the land were not entitled to an allowance for depletion. Parsons involved comparatively little investment in any particular mines. The coal was obtained through a strip-mining process which consists of removing the earth which lies over the coal, and then removing the coal uncovered. The entire investment of petitioners in Parsons took the form of equipment, such as mechanical shovels, trucks and bulldozers, which 'was movable and usable elsewhere in strip mining and * * * for other purposes.' Parsons v. Smith, supra, at 219, 79 S.Ct. at 660. In fact, one of petitioners in Parsons was primarily a roadbuilding firm. It insisted upon a contract terminable by either party on 10 days' notice since, "* * * if an opportunity opened up, (it) wanted to go back to road building," id., at 216, 79 S.Ct. at 658, for which its shovels and bulldozers were primarily designed. The contracts of both petitioners in Parsons were made terminable on very short notice. Thus the strippers in Parsons were clearly independent contractors hired to do the stripping, not entrepreneurs with a fixed investment in a particular mine.

On the other hand, the mines here involved were not strip mines but deep underground mines. The mine operators in the instant case had to use a drift, rather than a strip, method of mining. Unlike a strip-mine contractor, who can begin full production immediately upon removal of the overburden with one employee and a mechanical shovel, the driftmine operators here had to employ a number of miners and spend many months opening the underground mines. The operations of the miners here included cutting shafts, building a railroad spur, opening ventilation tunnels, shoring the roof of the mine, removing rock and unmarketable coal, and developing entries, cross sections, rooms and air courses, etc. Normally six to eight weeks was required before any marketable coal was reached and several months before the mine reached the production ^[1] stage. Moreover, even after the production stage was reached, the miners had to face and prepare pillars of coal for support, and frequently they spent many weeks excavating worthless 'rolls' of nonmarketable rock or removing excess water from the mines. All this activity required considerable capital investment.

Kyva and Standard, the two partnerships of mine operators involved here, state without challenge that as of the end of 1956, they had invested in machinery, $33,263.81 and $26,901.30, respectively. Their expenses during their first year of operation were, respectively, $76,036.64 and.$73,214.02. This expense was primarily capital expense representing investment in the mine, making it ready for exploitation of the coal in place. Unlike Parsons where the bulldozers, trucks and shovels were movable and primarily designed for road building and other work, the major part of the mine operators' capital investment here consisted of labor costs and was usable only in this particular underground mine operation. The mine operators could look for a return of their investment only to sales of the coal which they were to mine. Moreover, the Court of Appeals held that Paragon's contracts with the operators were not terminable at will or upon short notice, and that 'the operators had a continuing right to produce the coal and to be paid therefor at a price which was closely related to the market price.' 330 F.2d 161, 163. Under these circumstances I believe it undeniable that the operators invested considerable time, labor, and equipment in the coal in place. In order to extract the mineral, they pooled their resources, funds, and energies with Paragon, which supplied its base interest and made other investment necessary for processing and marketing the coal. I would hold, with the Court of Appeals, that the operators as well as Paragon fit within the rule enunciated in Palmer v. Bender, supra, and followed in other cases, ^[2] and that they had an economic interest in the mineral in place which entitled them to an allowance for depletion.

The Court tries to assimilate this case to Parsons by stating that Paragon could have terminated the interest of the operators in the coal at any time and that the rators had no right to mine their coal veins to exhaustion. The actual facts, however, reveal that Paragon has never taken steps, nor given the slightest information that it might take steps, to terminate anyone's contract. As a matter of practical fact the operators could count on mining the coal vein so long as coal remained and selling that coal to Paragon at a rate which varied slightly with the market price of coal. Additionally, the Court of Appeals found that the operators had 'a right to mine to exhaustion,' and a 'continuing right to produce the coal and to be paid therefor at a price which was closely related to the market price.' 330 F.2d, at 163. Whether or not the actions of the parties would produce these legal results is, of course, a question of state law. And, it is a clear rule of long standing that this Court, in the absence of exceptional circumstances, accepts the determinations of the Court of Appeals, the members of which are closer to the local scene than we, on questions of local law. General Box Co. v. United States, 351 U.S. 159, 165, 76 S.Ct. 728, 732, 100 L.Ed. 1055; Allegheny County v. Frank Mashuda Co., 360 U.S. 185, 191, 79 S.Ct. 1060, 1064, 3 L.Ed.2d 1163; Ragan v. Merchants Transfer & Warehouse Co., 337 U.S. 530, 534, 69 S.Ct. 1233, 1235, 93 L.Ed. 1520. Moreover, in view of the operators' considerable investment in the mines and their substantial reliance on being able to work those mines, I should be most surprised were state courts, contrary to the view of the Court of Appeals, to allow Paragon to terminate the contracts at will or to lower drastically the price it paid for the coal deliberately in order to drive particular operators out of business. Thus this case differs from Parsons not only because here the operators had a substantial fixed and unmovable investment in each particular mine, but also because here the operators had a right to mine the coal until it was exhausted in order to attempt to recover their investment and make a profit. In Parsons, as I have noted, it was the strip operator itself which insisted upon terminability so that it would be free to move its equipment to more profitable and unrelated opportunities.

The Court, in reaching its result, relies upon Treasury Regulations § 1.611-1(b)(1) and Helvering v. Bankline Oil Co., 303 U.S. 362, 58 S.Ct. 616, 82 L.Ed. 897. With all deference I do not believe that either the regulation or Bankline Oil bears significantly upon the issue here presented. The regulation in its entirety makes clear that '(a)n economic interest is possessed in every case in which the taxpayer has acquired by investment any interest in mineral in place * * * and secures, by any form of legal relationship, income derived from the extraction of the mineral * * *. But a person who has no capital investment in the mineral deposit * * * does not possess an economic interest merely because through a contractual relation he possess(es) a mere economic or pecuniary advantage derived from production.' ^[3] The regulation thus indicates that the question to be asked is whether the mine operators have a significant investment in the coal in place. I think it clear from the facts I have recited that their investment has given them an economic interest in the coal. Bankline Oil held that a processor of natural gas who received the gas at the mouth of the well and "* * * had no enforceable rights whatsoever under its contracts prior to the time the wet gas was actually placed in its pipe line," 'had no capital investment in the mineral deposit,' for he 'had no interest in the gas in place.' 303 U.S., at 368, 58 S.Ct. at 618. The facts that 'the taxpayer's capital investment was in equipment facilitating delivery of the gas produced rather than in equipment for production of gas, * * * that its function was not production of gas but the processing of gas,' G.C.M. 22730, 1941-1 Cum.Bull. 214, 220, and that the taxpayer had no enforcible right to receive any gas from the well, ^[4] all adequately distinguish Bankline Oil from the case here before us.

Further, I find this case virtually indistinguishable from Commissioner of Internal Revenue v. Southwest Exploration Co., 350 U.S. 308, 76 S.Ct. 395, 100 L.Ed. 347. In Southwest Exploration, owners of uplands next to offshore oil drilling sites allowed drillers to use their land as a base for offshore drilling operations in return for 24 1/2% of the net profits derived from the oil recovered. Though no oil lay under the owners' land, under California law offshore oil could be extracted only from filled lands or by slant drilling from upland drill sites. The Court held, because the owners of the upland sites had contributed the use of their land, necessary for the extraction of the oil, in return for a share in the net profits from the production of oil, that they had 'an economic interest which entitle(d) * * * (them) to depletion on the income thus received.' 350 U.S., at 317, 76 S.Ct., at 400. The coal mine operators in this case made as significant an investment in the mine as did the upland owners in Southwest Exploration. Their contribution was as necessary for the extraction of the coal as was the land for the extraction of the oil. They were as dependent upon the coal for the recoupment of their investment as were the landowners upon the oil. Though the mine operators had little control over who bought the coal, there is no indication that the landowners had any control over who bought the oil. And the mine operators made a substantial investment in the mine-not an investment in machinery which could be moved from place to place or mine to mine, but a fixed investment of time and labor in opening and developing the mine. The coal mine operators could look only to a sale of the coal for the return of their investment.

The Court also attempts to draw support from §§ 631(b) and (c) of the Internal Revenue Code of 1954 as showing a congressional intent not to allow mine operators to share in the depletion allowance. These sections, however, have nothing to do with the issue of apportioning the depletion allowance here under consideration. They state only that the holders of certain passive kinds of income interest, such as royalty interests in coal like that of the lessor in this case-interests quite unlike those owned either by Paragon or the mine operators here-will not receive any allowance for depletion but instead will receive capital gains treatment for their income. See S.Rep.No. 781, 82d Cong., 1st Sess., 43, U.S.Code Congressional and Administrative Service, p. 1969. Section 631(b), a rather lengthy subsection, provides capital gains treatment for the income of certain passive owners of timber interests and states in part that '(f)or purposes of this subsection, the term 'owner' means any person who owns an interest in such timber, including a sublessor and a holder of a contract to cut timber.' This definition, by its very terms, applies only to § 631(b), a section with no bearing on the question at issue here. Section 631(c), also a lengthy subsection, provides for capital gains treatment for income arising from coal royalties. To make certain that only passive holders of royalties received capital gains treatment and that holders of working interests did not receive capital gains treatment but instead received a depletion allowance, Congress specifically excluded holders of working interests from the coverage of § 631(c). Congress stated that certain owners of royalty interests would receive capital gains treatment, but stated that '(t)his subsection shall not apply to income realized by any owner as a co-adventurer, partner, or principal in the mining of such coal, and the word 'owner' means any person who owns an economic interest in coal in place, including a sublessor.' This definition is meant to exclude from the coverage of § 631(c) not only mine operators, but also lessees such as Paragon, whose income does not arise from passive royalties. In my view, this sentence adequately does the job Congress intended for it to do, for the income of both mine operators and lessees falls within the scope of 'income realized by any owner as a co-adventurer, partners, or principal in the mining of such coal.' See S.Rep.No. 781, supra, at 43. ^[5]

Even were I to assume that the definitions of 'owner' in §§ 631(b) and (c) have a more direct bearing upon §§ 611, 613, and 614, the sections dealing with the depletion allowance, §§ 631(b) and (c) would not show that Congress did not intend to grant contract miners for coal any depletion allowance. '(A) holder of a contract to cut timber' may well have been included specifically in § 631(b)'s definition because Congress wished to make crystal clear that all holders of contracts to cut timber were to receive capital gains treatment for their income. See H.R.Rep. No. 1337, 83d Cong., 2d Sess., 59. Congress may not have included a similar provision in § 631(c) because it did not believe that the strip miner, whose function is similar to that of the holder of a contract to cut timber, should be brought within the coverage of § 631(c); or Congress may have felt that since lessees such as Paragon were not included within the coverage of § 631(c), holders of contracts to mine coal should similarly not have their income treated as a capital gain; or the issue of according capital gains treatment to the income of contract mine operators might not have been before the Committee when § 631 was being drafted. If §§ 631(b) and (c) have any relevance to this case, it must be in the fact that § 631(c) defines an owner as a person 'who owns an economic interest in coal in place' (emphasis added), thus indicating a specific congressional intent that formal legal ownership of the mineral should not be controlling.

Finally, it is argued that the operators were able to recover their investments through depreciation and to allow them depletion as well would be to permit a double recovery of their costs. This argument overlooks the fact that Paragon too is able to recover every cent of its investment through depreciation and amortization allowances in addition to depletion. The only investment made by Paragon which might be considered different in kind from that of the mine operators is Paragon's promise to pay a royalty to its lessors of between 30 and 40 cents per ton of coal. ^[6] This royalty was fully deductible from Paragon's income. Despite the fact that to allow a lessee to share in the depletion allowance is to allow a double deduction, Congress affirmatively stated its intent to allow lessees of land to share in this allowance. See Internal Revenue Code of 1954, § 611(b)(1). Perhaps allowing both a depletion allowance and depreciation is inequitable, but this is a congressional decision which is not for us to question.

I conclude that the depletion allowance should be properly apportioned between the lessee and the coal mine operators. The operators were not employees or independent contractors hired to perform services. Unlike a man hired to mow a lawn, or shovel snow, or strip-mine coal, they made a substantial investment in opening and developing each individual mine and could look only to proceeds of the sale of coal extracted for a return of that investment. Under these circumstances I believe that the operators meet the test of Palmer v. Bender, supra, which undisputedly applies here, for they have 'an economic interest in the * * * (coal), in place, which is depleted by production.' 287 U.S. at 557, 53 S.Ct. at 227, 77 L.Ed. 489. While, clearly, the 'phrase 'economic interest' is not to be taken as embracing a mere economic advantage derived from production,' Helvering v. Bankline Oil Co., 303 U.S. 362, 367, 58 S.Ct. 616, 618, 82 L.Ed. 897, the operators here, unlike the strip miners in Parsons, do not merely derive an economic advantage through production; they also have a substantial capital investment in the mineral in place. To refuse to recognize this merely because the operators do not hold legal title to the coal is, in my view, a blind following of form, which I cannot accept. ^[7] To hold that the operators here are, in fact, like sellers of services is equally unrealistic. I would accept the sound view of the Court of Appeals-the members of which come from local mining areas-that the operators are substantial investors in the coal, and, in accordance with what I believe to be the intent of Congress, I would require that they be permitted a share of the allowance for depletion.

Notes

1. For the applicable definition of production stage, see Treas.Reg. § 1.616-2(b).
2. See, e.g., Burton-Sutton Oil Co. v. Commissioner of Internal Revenue, 328 U.S. 25, 32, 66 S.Ct. 861, 865, 90 L.Ed. 1062; Kirby Petroleum Co. v. Commissioner of Internal Revenue, 326 U.S. 599, 603, 66 S.Ct. 409, 411, 90 L.Ed. 343; Helvering v. O'Donnell, 303 U.S. 370, 371, 58 S.Ct. 619, 620, 82 L.Ed. 903; Thomas v. Perkins, 301 U.S. 655, 661, 57 S.Ct. 911, 913, 81 L.Ed. 1324.
3. Treas.Reg. § 1.611-1(b)(1) reads as follows:
4. The Court of Appeals found that the mine operators here had an enforcible right to mine the coal to exhaustion. See discussion, supra, at 642.
5. The Court points out that the mine operators do not claim to be a 'co-adventurer, partner, or principal' in the mining of the coal. Ante, at 637. The mine operators, however, do claim to be engaged in a type of joint venture with Paragon in mining the coal. It is understandable that they do not use the exact language of § 631(c), for that section has no bearing upon the question here at issue: whether they own an economic interest in the coal in place.
6. Paragon paid the mine operators between $4 and $5 per ton for the coal.
7. Compare this Court's rejection of the argument that only a legal interest can constitute a 'substantial interest' in a corporation in United States v. Boston & M.R. Co., 380 U.S. 157, 85 S.Ct. 868.